AB Municipal Income Portfolios
(Shares Offered—Exchange Ticker Symbol) |
AB National Portfolio (Class A–ALTHX; Class C–ALNCX; Advisor Class–ALTVX)
AB High Income Municipal Portfolio (Class A–ABTHX; Class C–ABTFX; Advisor Class–ABTYX; Class Z–ABTZX)
AB California Portfolio (Class A–ALCAX; Class C–ACACX; Advisor Class–ALCVX)
AB Arizona Portfolio (Class A–AAZAX; Class C–AAZCX; Advisor Class–AAZYX)
AB Massachusetts Portfolio (Class A–AMAAX; Class C–AMACX; Advisor Class–AMAYX)
AB Minnesota Portfolio (Class A–AMNAX; Class C–AMNCX)
AB New Jersey Portfolio (Class A–ANJAX; Class C–ANJCX)
AB New York Portfolio (Class A–ALNYX; Class C–ANYCX; Advisor Class–ALNVX)
AB Ohio Portfolio (Class A–AOHAX; Class C–AOHCX)
AB Pennsylvania Portfolio (Class A–APAAX; Class C–APACX)
AB Virginia Portfolio (Class A–AVAAX; Class C–AVACX; Advisor Class–AVAYX)
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c/o AllianceBernstein Investor Services, Inc.
P.O. Box 786003, San Antonio, Texas 78278-6003
Toll Free: (800) 221-5672
For Literature: Toll Free (800) 227-4618
STATEMENT OF ADDITIONAL INFORMATION September 30, 2024
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This Statement of Additional Information (“SAI”) is not a prospectus but supplements and should be read in conjunction with the current prospectus, dated September 30, 2024, for the AB National Portfolio (“National Portfolio”), AB High Income Municipal Portfolio (“High Income Portfolio”), AB California Portfolio (“California Portfolio”) and AB New York Portfolio (“New York Portfolio”, and together with the National, High Income and California Portfolios, the “Fund Portfolios”) of AB Municipal Income Fund, Inc. (the “Fund”) that offers the Class A, Class C, Advisor Class and Class Z (only for the High Income Portfolio) shares of
the Fund Portfolios, and for the AB Arizona Portfolio (“Arizona Portfolio”), AB Massachusetts Portfolio (“Massachusetts Portfolio”), AB Minnesota Portfolio (“Minnesota Portfolio”), AB New Jersey Portfolio (“New Jersey Portfolio”), AB Ohio Portfolio (“Ohio Portfolio”), AB Pennsylvania Portfolio (“Pennsylvania Portfolio”) and AB Virginia Portfolio (“Virginia Portfolio”, and together with the Arizona, Massachusetts, Minnesota, New Jersey, Ohio and Pennsylvania Portfolios, the “Fund II Portfolios”) of AB Municipal Income Fund II (the “Fund II”) that offers the Class A, Class C and Advisor Class (only for the Arizona Portfolio, Massachusetts Portfolio and the Virginia Portfolio) shares of the Fund II Portfolios (the Fund and Fund II are together referred to as the “Funds”; each of the Fund Portfolios and Fund II Portfolios is referred to as a “Portfolio” and together as the “Portfolios”) (together the “Prospectus”). Financial statements for the Portfolios for the fiscal year ended May 31, 2024 are included in the Funds’ Form N-CSR for the fiscal year ended May 31, 2024 filed with the Securities and Exchange Commission on August 8, 2024 and are incorporated into this SAI by reference. Copies of the Prospectus and the Funds’ financial statements may be obtained by contacting AllianceBernstein Investor Services, Inc. (“ABIS”) at the address or the “For Literature” telephone number shown above or on the Internet at www.abfunds.com.
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The [A/B] logo is a service mark of AllianceBernstein and AllianceBernstein® is a registered trademark used by permission of the owner, AllianceBernstein L.P.
DESCRIPTION OF THE PORTFOLIOS
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Introduction to the Portfolios
Except as otherwise noted, the Portfolios’ investment objectives and policies described below and in the Prospectus are not designated “fundamental policies” within the meaning of the Investment Company Act of 1940, as amended (the “1940 Act”), and may be changed by the Board of Directors or Board of Trustees of the Funds (each a “Board” and together, the “Boards”) with respect to a Portfolio without approval of the shareholders of such Portfolio. However, no Portfolio will change its investment objective without at least 60 days’ prior written notice to shareholders. There is no guarantee that the Portfolios will achieve their investment objectives.
Whenever any investment policy or restriction states a percentage of a Portfolio’s assets that may be invested in any security or other asset, it is intended that such percentage limitation be determined immediately after and as a result of the Portfolio’s acquisition of such securities or other assets. Accordingly, except with respect to borrowing, any later increases or decreases in percentage beyond the specified limitation resulting from a change in values or net assets will not be considered a violation of this percentage limitation.
Each Portfolio that invests in a particular state (“State Portfolio”) may invest in municipal securities issued by governmental entities (for example, U.S. territories) outside the named state if the municipal securities generate interest exempt from federal income tax and personal income tax in the named state. When AllianceBernstein L.P. (the “Adviser”) believes that municipal securities of the named state that meet a State Portfolio’s quality standards are not available, that State Portfolio may invest up to 20% of its total assets in securities whose interest payments are only federally tax-exempt.
Alternative Minimum Tax
Under current federal income tax law, interest on tax-exempt municipal securities issued after August 7, 1986 which are “specified private activity bonds,” and the proportionate share of any exempt-interest dividend paid by a regulated investment company that receives interest from such specified private activity bonds, will be treated as an item of tax preference for purposes of the alternative minimum tax (“AMT”) imposed on individuals, though for regular federal income tax purposes such interest will remain fully tax-exempt. Such private activity bonds (“AMT-Subject Bonds”), which include industrial development bonds and bonds issued to finance such projects as airports, housing projects, solid waste disposal facilities, student loan programs and water and sewage projects, have provided, and may continue to provide, somewhat higher yields than other comparable municipal securities.
In most instances, no state, municipality or other governmental unit with taxing power will be obligated with respect to AMT-Subject Bonds. AMT-Subject Bonds are in most cases revenue bonds and do not generally have the pledge of the credit or the taxing power, if
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any, of the issuer of such bonds. AMT-Subject Bonds are generally limited obligations of the issuer supported by payments from private business entities and not by the full faith and credit of a state or any governmental subdivision. Typically the obligation of the issuer of AMT-Subject Bonds is to make payments to bond holders only out of and to the extent of, payments made by the private business entity for whose benefit the AMT-Subject Bonds were issued. Payment of the principal and interest on such revenue bonds depends solely on the ability of the user of the facilities financed by the bonds to meet its financial obligations and the pledge, if any, of real and personal property so financed as security for such payment. It is not possible to provide specific detail on each of these obligations in which assets of a Portfolio may be invested.
Insurance Feature
The insurance feature is generally described in the Prospectus under “Additional Information about the Portfolios’ Strategies, Risks and Investments—Insured Securities.”
The Portfolios may obtain insurance on their municipal bonds or purchase insured municipal bonds covered by policies issued by monoline insurance companies. Currently, Assured Guaranty Municipal Corp. (“AGM”) is the insurer most actively writing policies on newly issued municipal bonds. AGM (formerly, Financial Security Assurance Holdings Ltd.) is an indirect subsidiary of Assured Guaranty Ltd. (“Assured”). In addition, Build America Mutual Assurance Company (“BAM”) insures newly issued municipal bonds. BAM is a New York domiciled mutual insurance company owned by the issuers of municipal bonds who use BAM to insure their debt obligations. Prior to the 2008-2009 financial crisis, there were several other insurers writing policies on municipal bonds, but the ratings of these insurers have been downgraded (in most cases, severely downgraded) and, while they are still insuring municipal bonds under policies written prior to the financial crisis, they generally are no longer writing new policies. It is possible that additional downgrades may occur. Certain nationally recognized statistical rating organizations’ (an “NRSRO”) ratings reflect the respective NRSRO’s current assessment of the creditworthiness of each insurer and its ability to pay claims on its policies of insurance. Any further explanation as to the significance of the ratings may be obtained only from the applicable NRSRO. The ratings are not recommendations to buy, sell or hold the municipal bonds, and such ratings may be subject to revision or withdrawal at any time by the NRSROs. Any downward revision or withdrawal of either or both ratings may have an adverse effect on the market price of the municipal bonds.
It should be noted that insurance is not a substitute for the basic credit of an issuer, but supplements the existing credit and provides additional security therefor. Moreover, while insurance coverage for the municipal securities held by the Portfolios may reduce credit risk, it does not protect against market fluctuations caused by changes in interest rates and other factors. As a result of declines in the credit quality and associated downgrades of most fund insurers, insurance has less value than it did in the past. The market now values insured municipal securities primarily based on the credit quality of the issuer of the security with little value given to the insurance feature. In purchasing insured municipal securities, the Adviser currently evaluates the risk and return of such securities through its own research.
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Risk of Concentration in a Single State
The primary purpose of investing in a portfolio of a single state’s municipal securities is the special tax treatment accorded the state’s resident individual investors. However, payment of interest and preservation of principal depend upon the continuing ability of the state’s issuers and/or obligors on state, municipal and public authority debt obligations to meet their obligations thereunder. Investors should be aware of certain factors that might affect the financial condition of issuers of municipal securities, consider the greater risk of the concentration of a Portfolio versus the safety that comes with a less concentrated investment portfolio and compare yields available in portfolios of the relevant state’s issues with those of more diversified portfolios, including out-of-state issues, before making an investment decision.
Municipal securities in which a Portfolio’s assets are invested may include debt obligations of the municipalities and other subdivisions of the relevant state issued to obtain funds for various public purposes, including the construction of a wide range of public facilities such as airports, bridges, highways, schools, streets and water and sewer works. Other purposes for which municipal securities may be issued include the obtaining of funds to lend to public or private institutions for the construction of facilities such as educational, hospital, housing, and solid waste disposal facilities. The latter, including most AMT-Subject Bonds, are generally payable from private sources which, in varying degrees, may depend on local economic conditions, but are not necessarily affected by the ability of the state and its political subdivisions to pay their debts. It is not practicable to provide specific detail on each of these obligations in which Portfolio assets may be invested. However, all such securities, the payment of which is not a general obligation of an issuer having general taxing power, must satisfy, at the time of an acquisition by the Portfolio, the minimum rating(s) described in the “Additional Information About the Portfolios’ Strategies, Risks and Investments—Municipal Securities” section of the Prospectus. See also “Appendix A: Bond and Commercial Paper Ratings” for a description of ratings and rating criteria. Some municipal securities may be rated based on a “moral obligation” contract which allows the municipality to terminate its obligation by deciding not to make an appropriation. Generally, no legal remedy is available against the municipality that is a party to the “moral obligation” contract in the event of such non-appropriation.
The following brief summaries are included for the purpose of providing certain information regarding the economic climate and financial condition of the states of New York, California, Arizona, Massachusetts, Minnesota, New Jersey, Ohio, Pennsylvania and Virginia, and are based primarily on information from official state documents referenced in the introduction to each state section, as well as other documents and sources, and do not purport to be complete. The Funds have not undertaken to verify independently such information and the Funds assume no responsibility for the accuracy of such information. These summaries do not provide information regarding many securities in which the Portfolios are permitted to invest and in particular do not provide specific information on the issuers or types of municipal securities in which the Portfolios invest or the private business entities whose obligations support the payments on AMT-Subject Bonds in which the Portfolios will invest. Therefore, the general risk factors as to the credit of the state or its political subdivisions discussed herein may not be relevant to the Portfolios. Although revenue obligations of a state or its political subdivisions may be payable from a specific project or source, there can be no assurance that future economic difficulties and the resulting impact on state and local government finances will not adversely
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affect the market value of a Portfolio or the ability of the respective obligors to make timely payments of principal and interest on such obligations. In addition, a number of factors may adversely affect the ability of the issuers of municipal securities to repay their borrowings that are unrelated to the financial or economic condition of a state, and that, in some cases, are beyond their control. Furthermore, issuers of municipal securities are generally not required to provide ongoing information about their finances and operations to holders of their debt obligations, although a number of cities, counties and other issuers prepare annual reports.
NEW YORK PORTFOLIO
The following is based primarily on information obtained from the Annual Information Statement of the State of New York, dated May 24, 2024.
Debt Reform Act of 2000
The Debt Reform Act of 2000 (“Debt Reform Act”) implemented statutory initiatives intended to improve the borrowing practices of the State of New York (the “State”). The Debt Reform Act applies to all new State-supported debt issued on and after April 1, 2000 and includes the following provisions: (a) a phased-in cap on new State-supported debt outstanding of 4% of personal income; (b) a phased-in cap on new State-supported debt service costs of 5% of total governmental funds receipts; (c) a limit on the use of debt to capital works and purposes only; and (d) a limit on the maximum term of new State-supported debt to 30 years.
The cap on new State-supported debt outstanding began at 0.75% of personal income in 2000-01 and was fully phased in at 4% of personal income in 2010-11. Similarly, the phased-in cap on new State-supported debt service costs began at 0.75% of total governmental funds receipts and was fully phased in at 5% in 2013-14.
The Debt Reform Act requires the limitations on the issuance of State-supported debt and debt service costs to be calculated by October 31 of each year and reported in the quarterly Financial Plan Update most proximate to October 31 of each year. If the calculations for new State-supported debt outstanding and debt service costs are less than the State-supported debt outstanding and debt service costs permitted under the Debt Reform Act, new State-supported debt may continue to be issued. However, if either the debt outstanding or the debt service cap is met or exceeded, the State, absent a change in law, would be precluded from contracting new State-supported debt until the next annual cap calculation is made and State-supported debt is found to be within the appropriate limitations. The Division of the Budget (“DOB”) intends to manage subsequent capital plans and issuance schedules consistent with the limits.
The State was found to be in compliance with the statutory caps for the most recent calculation period (Fiscal Year 2023).
One limited exception to the Debt Reform Act remains for issuances undertaken by the State for Metropolitan Transportation Authority (“MTA”) capital projects, which may be issued with maximum maturities longer than 30 years. This change allows bonds to be issued over the full useful life of the assets being financed, subject to Federal tax law limitations, and is
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consistent with the rules that would have been in effect if the MTA had directly financed the projects.
Previously, the State had enacted legislation suspending certain provisions of the Debt Reform Act for Fiscal Year 2021 and Fiscal Year 2022 bond issuances as part of the State response to the COVID-19 pandemic. Accordingly, any State-supported debt issued in Fiscal Year 2021 and Fiscal Year 2022 was not limited to capital purposes and was not counted towards the statutory caps on debt outstanding and debt service. The Fiscal Year 2023 Executive Budget reinstated the provisions of the Debt Reform Act for State-supported debt issued in Fiscal Year 2023 and beyond.
Current projections estimate that State-supported debt outstanding and State-supported debt service costs will continue to remain below the limits imposed by the Debt Reform Act. Based on the most recent personal income and debt outstanding forecasts, the available debt capacity under the debt outstanding cap is expected to decline from $25.9 billion in Fiscal Year 2024 to a low point of $800 million in Fiscal Year 2029. This calculation includes the estimated impact of funding capital commitments with State bonds. The debt service on State-supported debt subject to the statutory cap is projected at $3.8 billion in Fiscal Year 2025, or roughly $8.0 billion below the statutory debt service limit.
The State is one of the largest issuers of municipal debt, ranking second among the states, behind California, in the aggregate amount of debt outstanding. As of March 31, 2024, total State-related debt outstanding was estimated at $54.3 billion, excluding capital leases and mortgage loan commitments, equal to approximately 3.5% of personal income.
For purposes of analyzing the financial condition of the State, debt may be classified as State-supported debt and State-related debt. State-supported debt includes general obligation debt, to which the full faith and credit of the State has been pledged, and lease-purchase and contractual obligations of public authorities and municipalities, where the State’s legal obligation to make payments to those public authorities and municipalities is subject to and paid from annual appropriations made by the Legislature. State-related debt includes State-supported debt, as well as State-guaranteed debt (to which the full faith and credit of the State has been pledged), moral obligation financings and certain contingent-contractual obligation financings, where debt service is expected to be paid from non-State sources in the first instance, but State appropriations are available to make payments if necessary.
The State has never defaulted on any of its general obligation indebtedness or its obligations under lease-purchase or contractual obligation financing arrangements and has never been called upon to make any direct payments pursuant to its guarantees.
As of March 31, 2024, the total amount of general obligation debt outstanding was approximately $2.1 billion. The State projects that about $458 million in general obligation bonds will be issued in Fiscal Year 2025.
Also included in State-supported debt are certain long-term financing mechanisms, lease-purchase and contractual-obligation financings, including certificates of participation, which involve obligations of public authorities or municipalities where debt service
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is payable by the State, but are not general obligations of the State. Under these financing arrangements, certain public authorities and municipalities have issued obligations to finance certain payments to local governments (see “New York Local Government Assistance Corporation,” below), various capital programs, educational and health facilities, prison construction, housing programs and equipment acquisitions, and expect to meet their debt service requirements through the receipt of rental or other contractual payments made by the State.
The State currently has no plans to issue lease-purchase or other contractual-obligation financings. Since 2002, the Personal Income Tax (“PIT”) Revenue Bond Program has been the primary financing vehicle used to fund the State’s capital program. As of March 31, 2024, approximately $40.2 billion of State PIT Revenue Bonds were outstanding.
State Authorities
The fiscal stability of the State is related, in part, to the fiscal stability of its public authorities (the “Authorities”). Authorities, which have responsibility for financing, constructing and/or operating revenue producing public facilities, are not subject to the constitutional restrictions on the incurrence of debt that apply to the State itself and may issue bonds and notes within the amounts and restrictions set forth in their legislative authorizations. The State’s access to the public credit markets could be impaired, and the market price of its outstanding debt may be materially adversely affected, if any of its Authorities were to default on their respective obligations, particularly those using State-supported or State-related financing techniques. As of December 31, 2023 (and with respect to one authority, March 31, 2023), there were 15 Authorities that had outstanding debt of $100 million or more; total aggregate outstanding debt, including refunding bonds, was approximately $213 billion, only a portion of which constitutes State-supported or State-related debt.
Authorities’ operating expenses and debt service costs are generally paid by revenues generated by the projects financed or operated, such as tolls charged for the use of highways, bridges or tunnels, charges for public power, electric and gas utility services, tuition and fees, rentals charged for housing units, and charges for occupancy at medical care facilities. In addition, State legislation authorizes several financing techniques for Authorities. Also, there are statutory arrangements providing for State local assistance payments, otherwise payable to localities, to be made under certain circumstances to Authorities. Although the State has no obligation to provide additional assistance to localities whose local assistance payments have been paid to Authorities under these arrangements, if local assistance payments are so diverted, the affected localities could seek additional State assistance. Some Authorities also receive moneys from State appropriations to pay for the operating costs of certain of their programs.
The MTA, which receives the bulk of State appropriations to the Authorities, oversees New York City’s subway and bus lines 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 lines 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 (the
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“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 and will continue to depend on operating support from the State, local governments and the TBTA, including loans, grants and subsidies. Funding for transportation is projected to decrease due to the nonrecurrence of $305 million in Fiscal Year 2024 one-time funding to the MTA to address extraordinary financial impacts resulting from the pandemic. This decrease is partially offset in Fiscal Year 2025 by a $217 million projected increase, which includes an additional $34 million for non-MTA downstate transit systems and a $27 million increase in upstate transit aid. Not including one-time aid, MTA assistance is projected to grow by $145 million. The Innovative Mobility and All Other categories are scheduled to increase by $11 million.
Fiscal Year 2024
The State ended Fiscal Year 2024 in balance on a cash basis in the General Fund, based on preliminary unaudited results. General Fund receipts, including transfers from other funds, totaled $103.0 billion. General Fund disbursements, including transfers from other funds, totaled $100.1 billion. The State ended Fiscal Year 2024 with a General Fund balance of $46.3 billion, an increase of $2.9 billion from Fiscal Year 2023 results. The higher balance reflects a set aside for asylum seeker assistance, an increase for the reserves for labor settlements/agency operations, and additional net resources available at year-end that were carried forward to reduce the budget gaps in subsequent years.
Fiscal Year 2023
The State ended Fiscal Year 2023 in balance on a cash basis in the General Fund. General Fund receipts, including transfers from other funds, totaled $103.2 billion. General Fund disbursements, including transfers from other funds, totaled $92.8 billion. The State ended Fiscal Year 2023 with a General Fund balance of $43.5 billion, an increase of $10.4 billion from Fiscal Year 2022 results. The higher balance reflects the deposit of $10.6 billion to the State’s principal reserves, partially offset by use of prior year resources as planned to fund certain commitments and operations in Fiscal Year 2023.
Fiscal Year 2022
The State ended Fiscal Year 2022 in balance on a cash basis in the General Fund. General Fund receipts, including transfers from other funds, totaled $112.8 billion. General Fund disbursements, including transfers to other funds, totaled $88.9 billion. The State ended Fiscal Year 2022 with a General Fund balance of $33.1 billion, an increase of $23.9 billion from Fiscal Year 2021 results. A large share of the higher balance reflects $16.4 billion in Pass-Through Entity Tax collections and $1.1 billion in eligible public safety payroll expenses moved to the Common Retirement Fund, partly offset by prepayments and advances totaling $9 billion. Excluding these transactions, the General Fund ended March 2022 with a balance of $24.4 billion, an increase of $15.3 billion from Fiscal Year 2021 results.
Economic Overview
The State’s employment growth rates have been slowing since the beginning of 2023 due to labor shortages, elevated interest rates, and slowing global and national economic
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growth. The State’s economic and employment recovery lagged the national recovery in the years following the global pandemic. During this period, the State’s exposure to global financial market volatility heightened. In 2023, the State saw average job gains of 12,330 per month, down from an average of 20,990 per month in 2022. Persistently high inflation is expected to prolong elevated interest rates, creating additional obstacles to employment growth in the State by slowing growth in the financial sector as well as other interest-sensitive sectors such as construction.
Higher rates of out-migration due to remote work and soaring housing costs after the pandemic exacerbated the State’s declining population trend. This contributed to a further slowdown in employment growth in the State’s economy. The recent influx of international migration has offset some of this decline, but employment growth in many industries is likely to remain constrained. State employment is projected to increase by 0.8% in Calendar Year 2024, roughly half as fast as the U.S. economy, following a 2.1% growth rate in Calendar Year 2023.
The State’s recent employment growth performance has been uneven across many industrial sectors. Employment in eight of the State’s major sectors is still below their February 2020 pre-pandemic peaks. The size of the jobs deficit ranges from a gap of 1.7% in the government sector to a gap of 7.6% in the retail trade sector. In contrast, only four major sectors posted net job gains as of April 2024 relative to February 2020: financial services (1.3%), professional and business services (3.1%), transportation and utilities sector (4.8%), and education and health care (6.4%).
The State’s unemployment rate has been fluctuating near 4.3% since 2022, generally higher than that of the nation. The national unemployment rate for April 2024 was 3.9%, lower than the State’s rate of 4.2% for the same month. The statewide unemployment rate is affected disproportionally by the City of New York which posted an unemployment rate of 4.8% in April. The unemployment rate in the rest of the State was 3.8%.
In contrast to the nation, State personal income will grow by 4.3% in Calendar Year 2024 following 4.0% growth in Calendar Year 2023, before slowing slightly to 4.1% in Calendar Year 2025. These comparatively slower growth rates contribute to the current estimates of growth of personal income in Fiscal Year 2024 which remains weaker than the national rate. Total wages in Fiscal Year 2024 are estimated to grow by 3.4% for the State, a marked deceleration from 5.1% in Fiscal Year 2023. Looking further ahead, total State wage growth is projected to rebound to 4.0% for Fiscal Year 2025 as the outlook for bonus growth improves as discussed below. State personal income grew by 3.7% in Fiscal Year 2024 according to DOB estimates and should pickup to a growth rate of 4.5% in Fiscal Year 2025.
The State is the fourth most populous state in the nation and has a relatively high level of personal wealth. The State’s economy is diverse, with a comparatively large share of the nation’s financial activities, information, education and health services employment, and a small share of the nation’s farming and mining activity. The State’s location and its air transport facilities and natural harbors have made it an important link in international commerce. Travel and tourism constitute an important part of the economy.
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Manufacturing employment continues to stagnate as a share of total State non-farm employment, as in most other states. As a result, New York’s economy is less reliant on this sector than in the past. However, it remains an important sector of the State economy, particularly for the upstate region, which hosts higher concentrations of manufacturers.
The trade, transportation, and utilities supersector accounts for the second largest component of State non-farm employment but only the fifth largest when measured by wage share. This sector accounts for a smaller share of employment and wages for the State than for the nation.
New York City is the nation’s leading center for banking and finance. For this reason, the financial activities sector is far more important for the State than for the nation. Although this sector accounts for less than one-tenth of all non-farm jobs in the State, it accounts for one-fifth of total wages.
The services sector, which includes information, professional and business services, private education and healthcare, leisure and hospitality services, and other services accounts for over half of all non-farm jobs in the State. Information, education and health, and other services account for a higher proportion of total State jobs than for the nation.
Farming is an important part of the economy in rural areas, although it constitutes only 0.2% of total State GDP. According to the New York State Department of Agriculture and Markets, the State is the fifth largest dairy producer in the nation.
Federal, State and local government together comprise the third largest sector in terms of non-farm jobs. Public education is the source of over 40% of total state and local government employment.
The State is likely to be less affected than the nation as a whole during an economic recession that is concentrated in manufacturing and construction, but likely to be more affected during a recession that is concentrated in the services sector.
In the calendar years 1990 through 1998, the State’s rate of economic growth was somewhat slower than that of the nation. During the 1990-91 recession, the State, like much of the Northeast, experienced a greater economic contraction than the nation as a whole and was slower to recover. However, the situation improved subsequently. In 1999, for the first time in 13 years, State employment growth surpassed that of the nation, and in 2000 their growth rates were the same. In 2001, the September 11 attack resulted in a downturn in New York that was more severe than for the nation. In contrast, the State’s labor market fared better than that of the nation during the 2008 recession, though New York experienced a historically large wage decline in 2009. The State’s unemployment rate was higher than the national rate from 1991 to 2004. The State’s rate fell below the nation’s for much of the Great Recession in 2008 and 2009 and remained so until November 2011. The State’s unemployment rate rose above the national rate in December 2011 but fell below yet again in May 2015, where it remained competitive with the nation’s rate until the second half of 2016. As the early epicenter of the COVID-19 pandemic, New York was hit especially hard economically, with its unemployment rate soaring well above the nation’s rate throughout the pandemic. Correspondingly, New York had a more
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severe employment decline than the nation in 2020, and its job recovery has lagged the nation since then.
State per capita personal income has historically been significantly higher than the national average, although the ratio has varied substantially. Because New York City is an employment center for a multi-state region, State personal income measured on a residence basis understates the relative importance of the State to the national economy and the size of the base to which State taxation applies. In 2023, State per capita personal income was $79,581, compared to $68,531 for the nation as a whole.
New York City
The fiscal demands on the State may be affected by the fiscal condition of New York 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 New York City, and its related issuers, to market securities successfully in the public credit markets.
Other Localities
Certain localities outside New York City have experienced financial problems and have requested and received additional State assistance during the last several State fiscal years. While a relatively infrequent practice, deficit financing has become more common in recent years. State legislation enacted from 2004 includes 31 special acts authorizing bond issuances to finance local government operating deficits.
Like the State, local governments must respond to changing political, economic and financial influences over which they have little or no control. Such changes may adversely affect the financial condition of certain local governments. For example, the State or federal government may reduce (or in some cases eliminate) funding of some local programs which, in turn, may require local governments to fund these expenditures from their own resources.
Legislation enacted in 2013 created the Financial Restructuring Board for Local Governments (the “Restructuring Board”). The Restructuring Board consists of ten members, including the State Director of the Budget, the Attorney General, the State Comptroller, the Secretary of State and six members appointed by the Governor. Upon the request of a “fiscally eligible municipality,” the Restructuring Board is authorized to perform a number of functions, including a review of the municipality’s operations and making recommendations on reform and restructuring. The Restructuring Board is also authorized, upon the joint request of a fiscally eligible municipality and a public employee organization, to resolve labor impasses between municipal employers and employee organizations for police, fire and certain other employees in lieu of binding arbitration before a public arbitration panel.
Litigation
The State is a defendant in legal proceedings involving State finances and programs and miscellaneous civil rights, real property, and contract and other tort claims where the monetary claims against the State are deemed to be material, generally in excess of $300 million or involving significant challenges to or impacts on the State’s financial policies or
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practices. These proceedings could affect adversely the financial condition of the State in Fiscal Year 2025 or thereafter. Adverse developments in these proceedings or the initiation of new proceedings could affect the ability of the State to maintain a balanced Fiscal Year 2025 Financial Plan. The State believes that the Fiscal Year 2025 Financial Plan includes sufficient reserves to offset the costs associated with the payment of judgments that may be required during Fiscal Year 2025. Those reserves include (but are not limited to) amounts appropriated for Court of Claims payments and projected fund balances in the General Fund. There can be no assurance, however, that adverse decisions in legal proceedings against the State would not exceed the amount of all potential Enacted Budget resources available for the payment of judgments, and could therefore adversely affect the ability of the State to maintain a balanced Financial Plan.
CALIFORNIA PORTFOLIO
The following is based on information obtained from an Official Statement, dated April 11, 2024, relating to State of California $1,485,225,000 General Obligation Bonds, $885,225,000 Federally Taxable Various Purpose General Obligation Bonds and $600,000,000 Tax-Exempt Various Purpose General Obligation Bonds (the “Official Statement”), as well as data from the U.S. Bureau of Economic Analysis.
Constitutional Limits on Spending and Taxes
Certain State of California (“California” or the “State”) constitutional amendments, legislative measures, executive orders, civil actions and voter initiatives could adversely affect the ability of issuers of the State's municipal securities to pay interest and principal on municipal securities.
Article XIII B. The State is subject to an annual appropriations limit (the “Appropriations Limit”) imposed by Article XIII B to the State Constitution.
Article XIII B was modified substantially by Propositions 98 and 111 in 1988 and 1990, respectively. (See “Proposition 98” below.) “Appropriations subject to limitation,” with respect to the State, are 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 the 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 that are not “proceeds of taxes,” such as reasonable user charges or fees, and certain other non-tax funds.
Not included in the Appropriations Limit are appropriations for the 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, certain appropriations made in response to a declared emergency, and appropriations of certain special taxes imposed by initiative (e.g., cigarette and tobacco taxes). The Appropriations Limit may also be exceeded in cases of emergency.
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The State’s yearly Appropriations Limit is based on the limit for the prior year with annual adjustments for changes in California per capita personal income and population and, when applicable, any transfers of financial responsibility for providing services to or from another unit of government or any transfer of the financial source for the provision of services from tax proceeds to regulatory licenses, user charges, or user fees.
The Department of Finance projected the Appropriations Limit to be $141.492 billion and $148.054 billion under the Appropriations Limit in Fiscal Years 2023-2024 and 2024-2025, respectively. The proposed Governor’s budget for fiscal year 2024-25 (the “2024-25 Governor’s Budget”) estimates that the State is under the limit in fiscal year 2022-23 by $29.7 billion, which, when combined with the amount under the limit in fiscal year 2021-22 ($21.6 billion), results in the State being below the limit by $51.3 billion for the two-year period. The Governor’s Budget estimates that the State is under the limit in fiscal years 2023-24 and 2024-25 by $17.2 billion and $16.9 billion, respectively.
Proposition 98. On November 8, 1988, voters 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 local schools and community colleges (“K-14 schools”) a minimum share of General Fund revenues.
Proposition 98, as amended by Proposition 111 in 1990, is mainly comprised of a set of three formulas, or three tests, that guarantee schools and community colleges a minimum level of funding from the state General Fund and local property taxes, commonly referred to as the “minimum guarantee.” Which test applies in a particular year is determined by multiple factors including the level of funding in fiscal year 1986-87, local property tax revenues, changes in school attendance, growth in per capita personal income, and growth in per capita General Fund revenues. The applicable test, as determined by these factors, sets the minimum funding level. Most of the factors are adjusted frequently and some may not be final for several years after the close of the fiscal year. Therefore, additional appropriations—referred to as “settle-up” funds—may be required to fully satisfy the minimum guarantee for prior years. Final settle-up payments are determined as part of the Proposition 98 certification process, which occurs the fiscal year after the close of the related fiscal year; any outstanding settle-up balance owed to schools must be paid or scheduled to be paid as part of the state’s multi-year budgeting process.
Although the Constitution requires a minimum level of funding for education, the State may provide more or less than the minimum guarantee. If the State provides more than is required, the minimum guarantee is increased on an ongoing basis. If the State provides less than required, the minimum guarantee must be suspended in statute with a two-thirds vote of the Legislature. When the minimum guarantee is suspended, the suspended amount is owed to schools in the form of a maintenance factor. A “maintenance factor obligation” is also created in years when the operative minimum guarantee is calculated using a per capita General Fund inflation factor (Test 3) and is lower than the calculation using a per capita personal income inflation factor (Test 2). (In Test 1 years, a fixed percentage of General Fund revenues is used in the calculation.) In Test 3 years, the amount of maintenance factor obligation created is equal to the difference between the funded level and the Test 2 level. Under a suspension, the
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maintenance factor obligation created is the difference between the funded level and the operative minimum guarantee. The maintenance factor obligation is repaid according to a constitutional formula in years when the growth in per capita General Fund revenues exceeds the growth in per capita personal income.
The Proposition 98 guarantee is funded from the General Fund and other funds, including local property taxes.
Test 1 is operative in fiscal years 2023-24 and 2024-25, requiring approximately 39% of General Fund revenues to be spent on K-14 education. The 2024-25 Governor’s Budget reflects the Proposition 98 minimum guarantee at approximately $109.1 billion, an increase of approximately $768 million compared to the amount assumed for fiscal year 2024-25 in the 2023 Budget Act.
State Indebtedness
The State Treasurer is responsible for the sale of most 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 revenue obligations and short-term obligations, including revenue anticipation notes and revenue anticipation warrants, when due.
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 continuing appropriations from the General Fund of amounts for the payment of debt service on the related general obligation bonds. 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. Appropriations to pay debt service on any general obligation bonds cannot be repealed until the principal of and interest on such bonds have been paid. Certain general obligation bond programs, called “self-liquidating bonds,” receive revenues from specified sources so that moneys from the General Fund are not expected to be needed to pay debt service, but the General Fund will pay the debt service, pursuant to the continuing appropriation contained in the bond act, if the specified revenue source is not sufficient.
As of January 1, 2024, the State had approximately $77.8 billion of outstanding general obligation bonds and lease revenue bonds payable principally from the State’s General Fund or from lease payments paid from the operating budget of the respective lessees, which operating budgets are primarily, but not exclusively, derived from the General Fund. As of January 1, 2024, there were approximately $23.7 billion of authorized and unissued long-term voter-approved general obligation bonds which, when issued, will be payable principally from the General Fund and approximately $6.5 billion of authorized and unissued lease-revenue bonds.
The State’s general obligation bond law permits the State to issue as variable-rate indebtedness up to 20% of the aggregate amount of long-term general obligation bonds
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outstanding. The State Treasurer has adopted a Debt Management Policy that further reduces this limitation on variable rate indebtedness to 10% of the aggregate amount of long-term general obligation bonds outstanding. The terms of this policy, including this 10% limitation, can be waived or changed in the sole discretion of the State Treasurer. The State had outstanding $726.6 million of variable-rate general obligation bonds, representing about 1.03% of the State’s total outstanding general obligation bonds as of January 1, 2024.
In addition to general obligation bonds, the State acquires and constructs capital projects through the issuance of lease-revenue obligations (also referred to as lease-purchase obligations). Such borrowing must be authorized by the Legislature in a separate act or appropriation. Under these arrangements, the State Public Works Board, another State or local agency, or a joint powers authority uses proceeds of bonds to finance the acquisition or construction of a wide range of capital projects. These capital projects are leased to various state agencies under a long-term lease which provides the source of revenues which are pledged to the payment of the debt service on the lease revenue 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 marketed to investors. The State had $7.8 billion General Fund-supported lease-purchase debt outstanding as of January 1, 2024.
As part of its cash management program, prior to fiscal year 2015-16 the State regularly issued short-term obligations to meet cash flow needs. The State issued revenue anticipation notes (“RANs”) in all but one fiscal year between 1983 and 2014 and they have always been paid at maturity. RANs are issued 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 the succeeding fiscal year. More recently, with the State’s improved budget and cash position through fiscal year 2022-23, and the growth of internal borrowable resources from special funds including new reserve funds, the State has not had to use external borrowing such as the last RAN issue in fiscal year 2014-15. Based on current cash projections, no RANs are planned through fiscal year 2024-25, the tenth consecutive year in which external borrowing is not required.
Cash Management in Fiscal Year 2021-22, 2022-23, 2023-24, and 2024-25
The State entered fiscal year 2022-23 with a General Fund positive cash balance at June 30, 2022 of $84.6 billion. The State’s 2022-23 Governor’s Budget cash flow projections for fiscal year 2022-23 indicated that internal resources were sufficient and available to meet the state’s cash needs, while maintaining a cushion of at least $2.5 billion at all times. The State did not issue any RANs in fiscal year 2022-23.
The State entered fiscal year 2023-24 with a projected General Fund positive cash balance at June 30, 2023, of $14.0 billion. The State’s 2023-24 Governor’s Budget cash flow projections for fiscal year 2023-24 indicate that internal resources are sufficient and available to meet the state’s cash needs, while maintaining a cushion of $2.5 billion at all times. The State did not issue any RANs in fiscal year 2023-24.
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The 2024-25 Governor’s Budget cash flow projections for fiscal year 2024-25 assumes an estimated cash cushion of unused internal borrowable resources of at least $2.5 billion at all times. The State does not plan to issue any RANs in fiscal year 2024-25, the tenth consecutive year in which external borrowing is not required.
State fiscal officers constantly monitor the State’s cash position and if it appears that cash resources, including cash available through inter-fund borrowing, may become inadequate to meet the State’s General Fund payment obligations as they become due in such fiscal year such officers consider the use of other cash management techniques as described in the Official Statement, the issuance of RANs and/or seeking additional legislation.
The Budget Process
The State’s fiscal year begins on July 1 and ends on June 30 of the following year. The State’s General Fund Budget operates on a legal basis, generally using a modified accrual basis 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 and the State Constitution, 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 proposed Governor’s Budget, which is updated and revised by May 14 each year, the Legislature takes up the proposal. The voter-approved Balanced Budget Amendment (“Proposition 58”) requires the Legislature to pass a balanced budget bill, which means that for the ensuing fiscal year, projected General Fund expenditures must not exceed estimated General Fund revenues plus the projected beginning General Fund balance. These projections must be set forth in the budget bill. Proposition 58also provides for mid-year adjustments in the event the budget falls out of balance and the Governor calls a legislative special session to address the shortfall. The use of general obligation bonds, revenue bonds, and certain other forms of borrowing are prohibited to cover fiscal year end budget deficits. The restriction does not apply to certain other types of borrowing, such as: (i) short-term borrowing to cover cash shortfalls in the General Fund (including RANs or RAWs), or (ii) inter-fund borrowings.
Under the State Constitution, money may be drawn from the Treasury only though an appropriation made by law. The primary source of annual expenditure appropriations is the annual Budget Act as approved by the Legislature and signed by the Governor. Pursuant to Proposition 25, approved by the voters in November 2010, the Budget Act (and other appropriations bills/“trailer bills” which are related to the budget) must be approved by a majority vote of each House of the Legislature, and legislators must forfeit their pay during any period in which the Legislature fails to pass the budget bill on time. Continuing appropriations, available without regard to fiscal year, may also be provided by statute or by the State Constitution. The Governor may reduce or eliminate specific line items in the Budget Act or other bills that amend the Budget Act without vetoing the entire bill. Such individual line-item vetoes are subject to override by a two-thirds vote of each House of the Legislature.
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Current State Budget (Fiscal Year 2024-25)
The 2024-25 Governor’s Budget, released on January 10, 2024, projects an estimated General Fund shortfall of $37.9 billion largely driven by the substantial decline in the stock market in 2022 that negatively impacted revenues in fiscal year 2022-23 and the unprecedented delay in critical income tax collections for tax year 2022. Most cash data relating to the prior tax year is normally available by April to inform the May revision of the Governor’s January budget proposal. In 2023, due to California’s conformity with federal tax filing and payment deadline delays for over 99% of California taxpayers deemed impacted by winter storms, a significant portion of the State’s revenues from personal income tax and corporation income tax attributable to tax year 2022 were not due until November 2023. While the May revision of the Governor’s January budget proposal for fiscal year 2023-24 and the 2023 Budget Act did project a significant decline in revenues in fiscal year 2022-23, the actual cash data through November 2023 showed that the decline in revenues was steeper than estimated by $25.7 billion, 22 percent lower than projected at the 2023 Budget Act. This is a significant reason why the forecasts in the 2024-25 Governor’s Budget of personal income, corporate income and sales tax revenues, the State’s three biggest revenue sources, for fiscal years 2022-23 through 2024-25 have decreased by approximately $42.9 billion as compared to the 2023 Budget Act, before accounting for budget solutions. This decreased projection of revenues has led to significant projected operating deficits in future fiscal years. The Legislature must enact a balanced budget annually, but operating deficits are not unusual and will be addressed in future years as mandated by the balanced budget requirement and as estimates are refined.
General Fund revenues and transfers for fiscal year 2024-25 are projected at $214.7 billion, an increase of $17.8 billion, or 9.1% compared with a revised estimate of $196.9 billion for fiscal year 2023-24. These estimates include revenue transfers into the Budget Stabilization Account (“BSA”) of $1.4 billion and $12 billion in fiscal years 2023-24 and 2024-25, respectively. These revenue transfers into the BSA have the effect of lowering (transfer to) or raising (transfer from) reported levels of General Fund revenues and transfers.
General Fund expenditures for fiscal year 2024-25 are projected at $208.7 billion, a decrease of $22.2 billion, compared with a revised estimate of $230.9 billion for fiscal year 2023-24.
The 2024-25 Governor’s Budget proposes K-12 Education funding of $96.0 billion, Higher Education funding of $28.0 billion, Health and Human Services funding of $111.6 billion, and Corrections and Rehabilitation Agency funding of $18.1 billion.
The 2024-25 Governor’s Budget is based on a variety of estimates and assumptions. If actual results materially differ from those estimates and assumptions, the State’s financial condition may be materially different than anticipated in the 2024-25 Governor’s Budget. The State faces certain risks with potentially significant adverse General Fund impact including, but not limited to, inflation, high interest rates and the threat of recession, capital gains volatility, personal income tax and corporation income tax volatility, future tax deadline delays, the 2024 San Diego County tax deadline delay, global relations and trade, health care costs,
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housing constraints, debts and liabilities, climate change, energy risks, cybersecurity risks and pandemics.
Markets for goods, services, and financial assets are globalized, and economic slowdowns in other countries or regions, geopolitical tensions, and deteriorating international trade relations may hamper the national and state economies. The course of the Russian invasion of Ukraine remains uncertain, although the war does not appear to have significantly affected the State’s economy or budget to date. Neither have the recent outbreak of war in Gaza or increased tensions between China and Taiwan, and the 2024-25 Governor’s Budget does not project any worsening disruptions throughout the forecast window.
In addition, the State has historically been susceptible to wildfires and hydrologic variability. As greenhouse gas emissions continue to accumulate, climate change will intensify and increase the frequency of extreme weather events, such as coastal storm surges, drought, wildfires, floods, and heat waves, and raise sea levels along the coast. Over the past several years, the State has already experienced the impacts of climate change through a multi-year drought, flooding, and unprecedented wildfires. The specific timing and severity of future fiscal impacts of climate change on the State budget is difficult to predict but could be significant. The State is in the process of implementing various resilience measures to reduce the impacts of climate change, including significant investments in wildfire prevention, water infrastructure projects, and workforce development.
The 2023 Budget Act
The 2023 Budget Act preserved key investments from previous budgets in education, healthcare, climate crisis mitigation, housing, and infrastructure while employing a variety of measures to close a projected $31.7 billion shortfall in General Fund revenues. The 2023 Budget Act avoided new significant ongoing spending commitments and maintained a record $37.8 billion in total budgetary reserves. The 2023 Budget Act included K-12 Education funding of $95.0 billion, Higher Education funding of $27.8 billion, Health and Human Services funding of $113.5 billion, and Corrections and Rehabilitation Agency funding of $18.5 billion.
The 2022 Budget Act
The 2022 Budget Act maintained budget resiliency and a strong foundation to manage through the potential downturns in the State and national economies. The 2022 Budget Act continued to build reserves and pay down the State’s debts and liabilities. The 2022 Budget Act included K-12 Education funding of $95.4 billion, Higher Education funding of $29.4 billion, Health and Human Services funding of $101.2 billion, and Public Safety funding of $18.8 billion.
Economic Overview
The State of California is by far the most populous state in the nation, with an estimated 39.1 million residents as of July 2023. Its population is approximately 28% larger than that of the second most populous state, and the State contains approximately 12% of the total U.S. population. While the State’s population decreased slightly in fiscal year 2022-23 (from 39.15 million to 39.1 million), the State’s population is projected to grow marginally over the
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long term, albeit more slowly than in the past, to reach 39.5 million residents by 2060.
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, manufacturing, government, tourism, construction, and services. The makeup of the State economy closely resembles that of the national economy.
In 2023, California’s real GDP grew 2.1%; whereas the 2022-2023 national change was 2.5%. California’s preliminary unemployment rate in 2023 was 4.6%, compared to 3.6% for the United States. In 2023, per capita personal income in California averaged $80,423 compared to $68,531 for the nation. In 2023, the largest industry in California was finance, insurance, real estate, rental, and leasing (18.7%), followed by professional and business services (14.0%), information (10.7%), government and government enterprises (10.6%), and educational services, health care, and social assistance (7.6%).
Litigation
The State is a party to numerous litigation matters. Certain of these proceedings have been identified by the State as having a potentially significant fiscal impact upon revenues or expenditures of the State’s General Fund or the amount of State funds available to be borrowed by the General Fund.
ARIZONA PORTFOLIO
The following is based on information obtained from the Annual Financial Report of the State of Arizona for the fiscal year ended June 30, 2023 and the Annual Comprehensive Financial Report of the State of Arizona for the fiscal year ended June 30, 2022, as well as other data from the U.S. Bureau of Economic Analysis, the U.S. Bureau of Labor Statistics and the U.S. Census Bureau.
Economic Climate
Fueled by multiple consecutive years of substantial tax reductions, the economy of the State of Arizona (“Arizona” or the “State”) was fast-growing in the 1990s. Personal income taxes were slashed by 31% across the board, and in 2001 the State’s corporate income tax was reduced to 6.9% from 7.9%. From 1993 through 1999, the strongest seven-year period of job growth in Arizona history, almost 600,000 private sector jobs were created. According to U.S. Census data, the population of Arizona grew by 40% during the 1990s, second only to Nevada, and is projected to reach 10.5 million by 2055 (a 98% increase from 5.13 million in 2000). From 1990 to 2006 its population grew at a rate over three times that of the U.S. population. From 2010 to 2020 Arizona’s population grew by 11.9%. The population growth was driven by jobs, affordable housing, a warm climate and entrepreneurial flight from more heavily regulated states such as California. It is likely that affordable land and a pervasive pro-development culture will continue to attract employers and job seekers. The population growth rate in 2022 and 2023 was 1.3% and 0.9%, respectively.
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Overall, Arizona’s real GDP grew 2.7 from 2022 to 2023, and in 2023, the current-dollar GDP was $508.345 billion, making it the 18th largest economy in the United States. In 2022, the largest industry in Arizona was finance, insurance, real estate, rental and leasing (23.7%), followed by professional and business services (11.5%), government and government enterprises (11.1%), educational services, health care and social assistance (9.4%), and then retail trade (7.4%).
The seasonally adjusted unemployment rate in Arizona during June 2024 was 3.3%.
Geographically, Arizona is the nation’s sixth largest state (113,653 square miles). The State is divided into fifteen counties. Two of these counties, Maricopa County (including Phoenix) and Pima County (including Tucson), are more urban in nature and account for 76% of total population in Arizona, based on 2023 estimates.
Per capita income levels in Arizona have traditionally lagged behind the United States average. However, Arizona’s increase in per capita personal income was second in the nation in 1994 and led the nation in 1995. The diversification of Arizona’s economy, and its robust performance during the 1990s, led to these increases in per capita income, although Arizona still lags behind, and is expected to continue to lag behind, the United States average per capita income. In 2023, Arizona had a per capita personal income of $61,652, which was 90% of the national average, $68,531. Arizona’s 2023 per capita personal income ranked 41st in the United States.
Financial Condition
The Finance Division of the Arizona Department of Administration is responsible for preparing and updating financial statements and reports. The State’s financial statements are prepared in accordance with generally accepted governmental accounting principles.
While general obligation bonds are often issued by local governments, the State of Arizona is constitutionally prohibited from issuing general obligation debt. The State relies on pay-as-you-go capital outlays, revenue bonds, grant anticipation notes (“GANs”) and lease purchase transactions to finance capital projects. Each such project is individually rated based on its specific creditworthiness.
GANs are an innovative financing mechanism secured by revenues received from the Federal Highway Administration under a grant agreement and certain other Federal-Aid revenues. The State issued GANs to help pay for the costs of acquiring right-of-way for design and construction of certain controlled-access highways within Maricopa County. Lease purchase transactions are funded by certificates of participation (“COPs”). The State has used COPs primarily to construct prisons and to purchase and construct other buildings for State government operations. Additionally, the State has issued COPs to finance new school facilities approved by voters under Proposition 301. Total debt as reported by state agencies, universities, special districts and other political subdivisions was $35.9 billion at the close of June 30, 2023.
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Arizona’s Constitution provides that the State may contract debts not to exceed $350,000. This, as a practical matter, precludes the use of general revenue bonds for State projects. Additionally, certain other issuers have the statutory power to issue obligations payable from other sources of revenue that affect the whole or large portions of the State. The debts are not considered debts of the State because they are secured solely by separate revenue sources. For example, the Arizona Department of Transportation may issue debt for highways that is paid from revenues generated from, among other sources, State gasoline taxes. The three public universities in Arizona may issue debt for university building projects payable from tuition and other fees. The Arizona Power Authority and the University Medical Center may also issue debt.
Arizona’s Constitution also restricts the debt of certain of the State’s political subdivisions. No county, city, town, school district, or other municipal corporation of the State may for any purpose become indebted in any manner in an amount exceeding 6% of the taxable property in such county, city, town, school district, or other municipal corporation without the assent of a majority of the qualified electors thereof voting at an election provided by law to be held for that purpose; provided, however, that (a) under no circumstances may any county or school district of the State become indebted in an amount exceeding 15% (or 30% in the case of a unified school district) of such taxable property and (b) any incorporated city or town of the State with such assent may be allowed to become indebted up to a 20% additional amount for (i) supplying such city or town with water, artificial light, or sewers, when the works for supplying such water, light, or sewers are or shall be owned and controlled by the municipality, (ii) the acquisition and development by the incorporated city or town of land or interests therein for open space preserves, parks, playgrounds and recreational facilities, and (iii) the construction, reconstruction, improvement or acquisition of streets, highways or bridges or interests in land for rights-of-way for streets, highways or bridges. Irrigation, power, electrical, agricultural improvement, drainage, flood control and tax levying public improvement districts are, however, exempt from the restrictions on debt set forth in Arizona’s constitution and may issue obligations for limited purposes, payable from a variety of revenue sources.
Arizona’s local governmental entities are subject to certain other limitations on their ability to assess taxes and levies, which could affect their ability to meet their financial obligations. Subject to certain exceptions, the maximum amount of property taxes levied by any Arizona county, city, town or community college district for its operations and maintenance expenditures cannot exceed the amount levied in a preceding year by more than 2%. Certain taxes are specifically exempt from this limit, including taxes levied for debt service payments.
Arizona is required by law to maintain a balanced budget. To achieve this objective, the State has, in the past, utilized a combination of spending reductions and tax increases. For the 1990-91 budget, the Arizona Legislature increased taxes by over $250 million, which led to a citizen’s referendum designed to repeal the tax increase until the voters could consider the measure at a general election. After an unsuccessful court challenge, the tax increase went into effect. In 1992, Arizona voters adopted Proposition 108, an initiative and amendment to the State’s Constitution that requires a two-thirds vote by the Legislature and signature by the Governor for any net increase in State revenues, including the imposition of a new tax, an increase in a tax rate or rates and a reduction or elimination of a tax deduction. If the
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Governor vetoes the measure, then the legislation will not become effective unless it is approved by an affirmative vote of three-fourths of the members of each house of the Legislature.
Arizona accounts for its revenues and expenditures within various funds. The largest fund supporting the operation of State government is the General Fund, which accounts for the majority of receipts from sales and income taxes. The General Fund ended the June 30, 2023 fiscal year with a total fund balance of $4.9 billion, compared to the previous year’s total fund balance of $6.2 billion. The COVID-19 pandemic affected the normal operations and expenses of many State agencies. The Federal government Coronavirus Aid, Relief and Economic Security (“CARES”) Act state/local government aid allocation, known as the Coronavirus Relief Fund (“CRF”) provides resources to state/local governments. In addition, the Federal government American Rescue Plan Act (“ARPA”) was signed into law on March 11, 2021. The ARPA provides resources to State agencies to respond and to contain the economic and public health impacts of COVID-19. The CRF and ARPA uses for State government may have temporary impacts to ending fund balances. While some of this activity is reflected in the Annual Financial Report for the fiscal year ended June 30, 2023, there will be additional actions by the State through December 31, 2026, to expend ARPA resources.
Litigation
The State has a variety of claims pending against it that arose during the normal course of its activities. State management believes, based on advice of legal counsel, losses, if any, resulting from settlement of these claims will not have a material effect on the financial position of the State.
MASSACHUSETTS PORTFOLIO
The following was obtained from an Official Statement, dated June 5, 2024 relating to the Commonwealth of Massachusetts $750,000,000 General Obligation Bonds Consolidated Loan of 2024, Series B and $56,180,000 General Obligation Refunding Bonds 2024, Series B, as well as data from the U.S. Bureau of Economic Analysis.
Economic Climate
Over the past decade, Massachusetts (“Massachusetts” or the “Commonwealth”) has been a leader in job growth in the Northeast, driven largely by the state’s highly-educated workforce, the overall diversity of industries, and strengths in knowledge-based industries, such as health care, education, and professional services. While Massachusetts showed steady growth between the 2010 and 2020 census, the onset of the global COVID pandemic appears to have spurred some unique and new population patterns in the state. For example, while Massachusetts has experienced net population losses through domestic outmigration over the last 20 years, 2022 showed a dramatic increase in the Commonwealth’s domestic outmigration rate, essentially doubling from the typical outmigration seen in the Commonwealth over the last several years. Conversely, in both 2020 and 2021 international migration, which had slowed somewhat during the early part of the Trump administration, slowed dramatically due to pandemic related restrictions, only to finally return to a more typical rate for the Commonwealth in 2022. Massachusetts’ residents earn some of the highest incomes in the nation. Real per capita income
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has consistently exceeded incomes in New England and the U.S. and in 2022, Massachusetts had the second highest real per capita personal income in the nation, excluding the District of Columbia. The relatively high income levels reflect the high level of education and the concentration of high-wage industries such as health care, professional services, and finance and insurance. The poverty rate is lower in Massachusetts than in the nation at 9.9% compared to 12.5%. As a result of the COVID-19 pandemic, the unemployment rate in Massachusetts increased significantly to its peak of 17.1% in April 2020, compared to 2.9% in March 2020. The tightness of the current labor market is reflected in the unemployment rate, which has recently reached historically low levels. The January 2024 unemployment rate for Massachusetts was 3.0 percent, just above the historic low of 2.7 percent recorded at the end of the tech boom in the summer and fall of 2000 and among the lowest since these data were first collected in 1969.
Average per capita personal income for Massachusetts residents was $87,812 in 2023, which is 128.1% of the national average of $68,531. In 2023, Massachusetts had the highest per capita personal income in the United States. While per capita personal income is, on a relative scale, higher in Massachusetts than in the United States as a whole, this is offset to some extent by the higher cost of living in Massachusetts.
The COVID-19 pandemic and the numerous measures taken in response to it by international, federal, state and local governments, as well as private businesses and organizations, continue to have impacts on the global, national and state economies; the extent of any lasting impacts on and within the Commonwealth is still unknown.
Financial Condition
Under its Constitution, the Commonwealth may borrow money (a) for defense or in anticipation of receipts from taxes or other sources, any such loan to be paid out of the revenue of the year in which the loan is made, or (b) by a two-thirds vote of the members of each house of the Legislature present and voting thereon. Legislation enacted in December 1989 imposes a limit on the amount of outstanding “direct” bonds of the Commonwealth. The limit was set at $18.944 billion in Fiscal Year 2012. Amendments provided that the debt limit be calculated for fiscal years starting in Fiscal Year 2013 using a fiscal 2012 base value of $17.070 billion and increasing the limit for each subsequent fiscal year to 105% of the previous fiscal year’s limit. The statutory limit on direct debt during Fiscal Year 2024 is approximately $30.655 billion.
The Commonwealth is authorized to issue three types of direct debt—general obligation debt, special obligation debt and federal grant anticipation notes.
Certain independent authorities and agencies within the Commonwealth are statutorily authorized to issue bonds and notes for which the Commonwealth is either directly, in whole or in part, or indirectly liable. The Commonwealth’s liabilities with respect to these bonds and notes are classified as either (a) Commonwealth-supported debt, (b) Commonwealth-guaranteed debt or (c) indirect obligations.
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Fiscal 2023
On January 14, 2022, a fiscal 2023 consensus tax revenue estimate of $36.915 billion was agreed upon by the Secretary of Administration and Finance and the chairs of the House and Senate Committees on Ways and Means.
The estimate reflected projected 2.7% tax revenue growth over the revised projected fiscal 2022 tax revenue amount of $35.948 billion. The consensus revenue estimate for fiscal 2023 incorporated the reinstitution of the charitable deduction effective January 1, 2023.
After accounting for statutorily required transfers for pensions, and to the Massachusetts Bay Transportation Authority (“MBTA”), the Massachusetts School Building Authority (“MSBA”) and the Workforce Training Fund, the Secretary and Committee chairs agreed that $29.783 billion would be the maximum amount of tax revenue available for the fiscal 2023 budget.
On January 26, 2022, the Governor filed his fiscal 2023 budget recommendation, providing for a total of $48.5 billion in authorized spending, excluding projected transfers to the Medical Assistance Trust Fund. This represents an increase of 0.5% above fiscal 2022. The Governor’s budget proposal includes a supplemental transfer of $250 million to the Pension Liability Fund.
Alongside the budget proposal, the Governor filed a comprehensive tax proposal to provide relief for housing and childcare costs, relieve the tax burdens for very low-income taxpayers and improve the State’s competitiveness. The Governor’s fiscal 2023 budget recommendation incorporates these tax proposals.
The fiscal 2023 budget, as approved by the Governor on July 28, 2022, includes approximately $52.7 billion, excluding transfers to the Medical Assistance Trust Fund. This reflects approximately 9.3% growth in authorized spending over fiscal 2022, including major one-time transfers such as the $266 million reserve to support MBTA safety and workforce initiatives, a $175 million transfer to a new trust fund dedicated to supporting high-quality early education and care, a $150 million transfer to the Student Opportunity Act Investment Fund, a $100 million supplemental transfer to the Commonwealth’s Pension Liability Fund, and a $100 million transfer to the State Retiree Benefits Trust Fund. The fiscal 2023 budget as approved by the Governor incorporates an increased $39.576 billion tax revenue forecast before various tax initiatives, which represents an increase of $2.660 billion over the fiscal 2023 consensus tax revenue estimate of $36.915 billion announced in January 2022, due to better-than-expected actual tax collections. The fiscal 2023 budget as enacted is in structural balance, with no planned Stabilization Fund withdrawal.
On January 30, 2023, the Governor filed a supplemental budget recommending $282 million in supplemental appropriations, at a net state cost of $154 million. Major spending items included $85 million to address urgent needs across the state’s family emergency shelter system, $132 million to create an offramp from the federal Supplemental Nutrition Assistance (“SNAP”) Emergency Allotments and reimburse certain victims of SNAP benefit theft, and $65 million to extend a universal school meals pilot program.
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On March 17, 2023, the Governor filed a supplemental budget recommending $734 million in supplemental appropriations that complement the Governor’s fiscal 2024 budget recommendation. It supports a few COVID-era programs for another year, including $171 million to extend the state-funded universal free school meals pilot program through the following school year. It provides an additional $35 million for the Massachusetts Clean Energy Center, as well as other one-time investments. It also includes $100 million to fully pay down pension liabilities attributable to the fiscal 2015 early retirement incentive program, as agreed upon by the Secretary of Administration and Finance and the chairs of the House and Senate Committees on Ways and Means on January 30, 2023.
Fiscal 2024
On January 30, 2023, a fiscal 2024 consensus tax revenue estimate of $40.410 billion and an estimate of $1 billion from the new 4% surtax on personal income above $1 million (adjusted annually for inflation in each tax year after 2023) approved through a ballot initiative in November 2022 (surtax revenue) were agreed upon by the Secretary of Administration and Finance and the Chairs of the House and Senate Committees on Ways and Means.
The fiscal 2024 consensus tax revenue estimate of $40.410 billion represents revenue growth of 1.6% from the revised fiscal 2023 estimate of $39.768 billion. The estimated $1 billion of additional income surtax revenue will be available in fiscal 2024 to support new education and transportation initiatives deriving from the requirements of the approved ballot initiative.
After accounting for statutorily required transfers for pensions, and to the MBTA, the MBSA and the Workforce Training Fund, the Secretary and Committee chairs agreed that $32.928 billion (exclusive of the expected additional income surtax revenue) would be the maximum amount of tax revenue available for the fiscal 2024 budget.
On March 1, 2023, the Governor filed her fiscal 2024 budget recommendation, providing for a total of $55.5 billion in authorized spending, including projected transfers to the Medical Assistance Trust Fund. This represents an increase of 4.1% above the fiscal 2023 budget, including new investments supported by income surtax revenue.
Alongside the budget recommendation, the Governor filed a comprehensive tax relief proposal that includes a new child and dependent care tax credit, a reduction in the estate tax, an increase to the renter deduction, a reduction in the rate of taxation on short-term capital gains and other specific relief for seniors and others. The Governor’s fiscal 2024 budget recommendation accounted for the tax relief proposal.
The fiscal 2024 budget was approved by the Governor on August 9, 2023. It provides for approximately $55.980 billion in authorized spending, including projected transfers to the Medical Assistance Trust Fund and accounts for a reduction of approximately $580 million of tax revenue related to subsequently enacted tax relief legislation. In signing the budget, the Governor vetoed $205 million in net spending. The fiscal 2024 budget is approximately 5.1% greater than fiscal 2023 estimated spending levels at the time of the
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Governor’s approval. The fiscal 2024 budget as approved by the Governor incorporates an increased $40.830 billion in tax revenue forecast, which reflects the consensus tax revenue estimate of $40.410 billion and the $1 billion estimate of revenue from the new 4% surtax on personal income above $1 million, reduced by a $580 million set aside for tax relief. The fiscal 2024 budget also adopted the Governor’s proposal for a new Education and Transportation Fund that will segregate all income surtax revenue from the General Fund and ensure that it is only invested in education and transportation, as intended by the ballot initiative. Revenues will be estimated and certified quarterly, with additional annual reporting of both revenues and expenditures as a transparency and accountability measure. The enacted legislation includes a number of additional safeguards. For example, a required minimum fund balance is reserved to insulate recurring spending from volatility and periods of economic downturn, with use of the reserve requiring a two-thirds vote of both the House and the Senate, mirroring controls on use of the Stabilization Fund. Annual, recurring spending is also limited to ensure sustainability as revenues fluctuate, with income surtax revenue collected in excess of the limit to be used for one-time investments, such as pay-as-you-go capital, start-up grants, studies, and enabling projects.
On October 4, 2023, the Governor signed into law tax relief legislation that is expected to reduce revenues by $577 million in fiscal 2024 on a gross basis and $519 million in fiscal 2024 on a net basis accounting for off-budget capital gains transfers to the stabilization fund, eventually annualizing to slightly more than $1 billion by fiscal 2028. The fiscal 2024 budget set aside $580 million on net to cover the cost of this tax relief legislation. The legislation provides for the following changes to the current tax rates in the Commonwealth: (i) reduces the tax rate on gains from the sale of capital assets held for one year or less (short-term capital gains) from 12.0% to 8.5% effective for tax year 2023, (ii) reduces all taxpayer’s estate tax and eliminates the tax for all estates under $2 million by allowing a uniform credit of $99,600, (iii) increases the child and dependent tax credit from $180 to $310 for tax year 2023 and $440 for tax year 2024 and beyond, and eliminates the cap on dependents that can qualify, (iv) increases the earned income tax credit from 30% to 40% of the federal credit, (v) moves from a corporate excise multistate apportionment system that factors in property, payroll, and sales to an apportionment system that only considers sales effective January 1, 2025, (vi) doubles the base maximum amount for the senior circuit breaker tax credit from $750 to $1,500, which, after cumulative cost-of-living adjustments, provides a $2,590 maximum credit for the 2023 tax year, (vii) increases the cap on the rental deduction from $3,000 to $4,000, and (viii) triples the maximum credit for title V cesspool or septic systems to $18,000 and increases the amount claimable to $4,000 per year. The legislation also (i) increases the cap on the Stabilization Fund balance from 15% to 25.5% of budgeted revenues, (ii) increases the cap on the Commonwealth’s Housing Development Incentive Program from $10 million to $57 million in fiscal 2024 and $30 million in future years, (iii) increases the base cap for Low-Income Housing Tax Credits from $40 million to $60 million, (iv) permits municipalities to adopt a local property tax exemption for affordable real estate that is rented to occupants with income of 200 percent or less of the area median income, (v) provides a deduction for employer student loan payments that exceeds the federal cap and, unlike the federal exclusion, does not sunset, and (vi) makes certain adjustments to lead paint abatement, dairy tax credits, commuter tax benefits, senior volunteer service property tax abatements, apprenticeship tax credits and the cider tax. The legislation also requires married taxpayers who filed a joint federal income tax return to file a joint Massachusetts personal income tax return starting in tax year 2024. The legislation also requires
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that the Department of Revenue submit monthly reports to the Legislature with an estimate of if, and when, net state tax revenue may exceed the allowable state tax revenue under Chapter 62F, and provides that in the event net state tax revenue exceeds allowable state tax revenue, the credit due is applied in an equal amount to all taxpayers, replacing the proportional distribution previously required by Chapter 62F.
On August 8, 2023, Governor Healey declared a state of emergency in Massachusetts due to rapidly rising numbers of families, including newly arriving immigrants and refugees, seeking emergency shelter and supportive services in Massachusetts. Governor Healey called upon the federal government to take urgent action to expedite work authorizations and increase funding to states to assist in providing shelter and services to these families. In October 2023, the Governor announced that Massachusetts could not safely expand its shelter capacity beyond 7,500 families. The Governor also announced additional actions to address the surge in family homelessness and emergency shelter demand, including appointing an Emergency Assistance Director to oversee management and coordination of the emergency shelter system, prioritizing helping families to exit into more permanent housing options, connecting shelter residents with work opportunities, and seeking additional resources, including federal relief. In November and December, the Commonwealth partnered with the U.S. Department of Homeland Security on a Work Authorization Legal Clinic to assist work-eligible migrants in emergency family shelters with obtaining work authorizations.
As of June 2024, the Governor has approved two supplemental appropriations to support the emergency shelter program and associated services. On December 4, 2023, the Governor approved $260 million in supplemental appropriations which included $10 million for resettlement agencies. On April 30, 2024, the Governor approved an additional $426 million in supplemental appropriations to continue ongoing emergency shelter support of which $251 million is intended to support services through the end of fiscal 2024, with the remaining $175 million set aside for fiscal 2025, if needed. The $175 million of fiscal 2025 support would be in addition to funds included in the proposed fiscal 2025 budget and would only be used if the Secretary of Administration and Finance issued a written determination that the supplemental funds are necessary. On April 30, 2024, the Governor also approved a new law that limits how long families can live in emergency shelters to nine months, with certain exceptions.
On January 7, 2024, the Secretary of Administration and Finance revised the tax revenue estimate for fiscal 2024 to $39.410 billion (excluding income surtax revenues), representing a reduction of $1.0 billion from the prior consensus tax revenue estimate. Pursuant to Section 9C of Chapter 29 of the Massachusetts General Laws, the Secretary advised the Governor of an estimated budgetary shortfall of revenues totaling $1.0 billion with respect to the appropriations approved to date for fiscal 2024. On January 8, 2024, the Governor announced a $375 million reduction in spending allotments for fiscal year 2024 pursuant to Section 9C authority and identified additional revenue solutions (non-tax) worth $625 million, including higher than projected interest collections and departmental revenues.
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Fiscal 2025
On January 8, 2024, a fiscal 2025 consensus tax revenue estimate of $40.202 billion, as well as a $1.3 billion estimate of revenue from the 4% surtax on personal income above the surtax threshold of $1 million (adjusted for inflation annually in each tax year after 2023), were agreed upon by the Secretary of Administration and Finance and the chairs of the House and Senate Committees on Ways and Means. The fiscal 2025 consensus tax revenue estimate of $40.202 billion (excluding estimated income surtax revenues) represents revenue growth of 2% above the revised fiscal 2024 estimate of $39.410 billion. The estimated $1.3 billion of additional income surtax revenue will be available in fiscal 2025 to support additional spending on education and transportation initiatives.
After accounting for statutorily required transfers for pensions, and to the MBTA, the MSBA and the Workforce Training Fund, the Secretary and Committee chairs agreed that $32.904 billion (exclusive of the expected additional income surtax revenue) would be the maximum amount of tax revenue available for the fiscal 2025 budget.
On January 24, 2024, the Governor filed her fiscal 2025 budget recommendation, providing for a total of $56.1 billion in authorized spending, excluding projected transfers to the Medical Assistance Trust Fund. This represents an increase of 2.9% above the fiscal 2024 budget, excluding new investments supported by income surtax revenue.
The Governor’s budget recommendation has been filed with the Legislature for consideration in accordance with the Commonwealth’s annual budgeting process. The House of Representatives approved its version of the budget on April 10, 2024, and the Senate approved its version on May 7, 2024. The differences between the House and Senate versions are generally reconciled by a legislative conference committee during the month of June, so that a final version can be enacted by the Legislature and sent to the Governor for approval prior to the start of the new fiscal year on July 1. It is not unusual for the budget process to extend slightly into the next fiscal year, with final enactment of the budget occurring in early or mid-July. Interim budgets are typically enacted to provide funding after the end of the fiscal year until the full budget can be enacted and approved by the Governor.
Litigation
There are pending in state and federal courts within the Commonwealth and in the Supreme Court of the United States various suits in which the Commonwealth is a party. In the opinion of the Attorney General, no litigation is pending or, to her knowledge, threatened which is likely to result, either individually or in the aggregate, in final judgments against the Commonwealth that would affect materially its financial condition.
MINNESOTA PORTFOLIO
The following was obtained from an Official Statement, dated August 6, 2024, relating to the State of Minnesota $1,593,755,000 General Obligation State Bonds, as well as information obtained from the Minnesota Management and Budget Department and the U.S. Bureau of Economic Analysis.
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Economic Climate
The population of the State of Minnesota (“Minnesota” or the “State”) grew by 7.6% from 2000 to 2010, compared to 9.6% growth in the United States as a whole during that period. During the period 2010-2020 the population in Minnesota grew by 7.6%, compared to 7.4% nationally. The population of the State in 2023 was 5,737,915. In total, the number of Minnesotans is estimated to have increased by 23,600 (0.40 %) in 2023. The State’s population growth is comprised of three parts: natural population increase (number of births less deaths), net domestic migration, and net international immigration.
In 2023, the structure of Minnesota’s economy paralleled the structure of the United States economy as a whole. In 2023, Minnesota current dollar GDP was $471.8 billion and ranked 17th in the United States. In 2023, Minnesota real GDP grew 1.2%; the 2022-2023 national change was 2.5%. The 2013-2023 compound annual growth rate for Minnesota real GDP was 1.5%; the compound annual growth rate for the nation was 2.3%.
In the period 2010-2020, non-farm employment in Minnesota increased by 13.2%, compared to a 9.1% increase for the nation. Jobs in construction and transportation, warehousing and utilities saw the biggest percent increase during that period. In the durable goods industries, the State’s employment in 2023 was highly concentrated in computers and electronic products, fabricated metal products, and machinery categories. In 2023, 40.9% of Minnesota’s non-durable goods employment was concentrated in food manufacturing. Over half of the State’s acreage is devoted to agricultural purposes.
In 2023, Minnesota had a per capita personal income of $71,866. This per capita personal income ranked 13th in the United States and was 104.9% of the national average. The 2023 per capita personal income reflected an increase of 4.3% from 2022. The 2022-2023 national change was 4.7%.
In 2023, Minnesota’s unemployment rate averaged 2.8%, compared with the national average of 3.6%.
During March and April 2020, Minnesota lost 416,000 jobs, approximately 14% of February 2020 payroll employment. In September 2023, Minnesota joined the majority of other states that have now recovered the number of jobs lost during the pandemic recession. Across the entire U.S., total employment surpassed the February 2020 level in June 2022. Through December, Minnesota’s total employment exceeds its pre-pandemic level by 0.5%, while U.S. employment is 3.2% above its pre-pandemic level.
Minnesota is susceptible to significant seasonal weather shifts during the course of a calendar year, including weather events such as flooding, tornadoes, blizzards, and drought. Future changes to the climate in Minnesota may produce ecological, environmental, and economic impacts on the State. Climate change as a result of emissions of greenhouse gasses may also produce ecological, environmental, and economic impacts on the State and additional federal and State regulations to fight climate change.
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Financial Condition
Minnesota operates on a biennial budget basis. Prior to each fiscal year, the Department of Management and Budget allots the applicable State agency appropriations based on legislatively-enacted budgets. An allotment is a subdivision of an appropriation into smaller, detailed components used by agencies to budget expenditures by category of expenditure. The accounting system prevents allotments from exceeding appropriations. The State’s principal sources of non-dedicated revenues are taxes of various types. The General Fund receives no unrestricted federal grants. The only federal funds deposited into the General Fund are to reimburse the State for expenditures on behalf of federal programs.
Prior to 1995, Minnesota law established a Budget Reserve and Cash Flow Account in the General Fund which served two functions. In 1995, the Minnesota legislature separated the Budget Reserve and Cash Flow Account into two separate accounts, the Cash Flow Account and the Budget Reserve Account, each having a different function.
The Cash Flow Account was established in the General Fund for the purpose of providing sufficient cash balances to cover monthly revenue and expenditure imbalances. The amount and use of funds in the Cash Flow Account is governed by statute. Minnesota’s Cash Flow Account remains at $350 million for the Current Biennium.
The Budget Reserve Account was established in the General Fund, as a special account (separate from the Cash Flow Account) that serves as a savings account to be used to offset budget shortfalls during economic downturns. The amount and use of funds from the Budget Reserve Account and its replenishment are governed by statute. If the Budget Reserve Account’s level is below the target and there is a positive forecast balance in the current biennium, up to 33% of the forecast balance is allocated to the Budget Reserve Account until the target level is reached.
Operating Budget
Major operating budget appropriations for each biennium are enacted during the final legislative session of the immediately preceding biennium (i.e., in odd-numbered calendar years). Supplemental appropriations and changes in revenue and expenditure measures are usually adopted during legislative sessions in even-numbered calendar years. Revenue and expenditure forecasts are performed in February and November of each calendar year. Forecasts are performed for the then-current biennium and for the next succeeding biennium. Based upon the results of these forecasts, the Governor may recommend revenue and expenditure changes that are then recommended to the legislature. In addition, the legislature may, also based on these forecasts, approve budget changes.
The February and November forecasts for the biennium during which the forecasts are made are used to evaluate if the State is on track to finish that biennium with a balanced budget, and may be used by the Governor and the legislature to revise the budget for that biennium.
The November forecast in even-numbered years for the next succeeding biennium becomes the basis for the Governor’s budget recommendations for that biennium. All subsequent
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February and November forecasts for that biennium supplement and revise the original even-numbered year November forecast with more current data, and the Governor may use these forecasts to submit modifications to the budget that was developed from the original even-numbered year November forecast.
The biennium that began on July 1, 2021, and ended on June 30, 2023, is referred to herein as the “Previous Biennium.” The biennium that began on July 1, 2023, and will end on June 30, 2025, is referred to herein as the “Current Biennium.” The biennium that will begin on July 1, 2025, and will end on June 30, 2027, is referred to herein as the “Next Biennium.”
February 2023 Forecast – Current Biennium
The November 2022 Forecast provided the first official forecast for the Current Biennium. The February 2023 Forecast provided updated estimated and projected balance of $17.455 billion for the Current Biennium, prior to the Legislature finalizing enacted appropriations for the Current Biennium.
Revenues: Total revenues for the Current Biennium were estimated to be $60.776 billion, an increase of $95 million (0.2%) over the February 2023 Forecast for the Previous Biennium revenues. Total tax revenues for the Current Biennium were estimated to be $58.320 billion, a 0.5% increase over the Previous Biennium forecast revenues. Growth of individual income tax and sales taxes accounted for nearly all the biennial tax revenue change. Of the major tax types, the corporate franchise tax, the state general property tax, and other tax revenues, showed declines in expected revenues from the Previous Biennium to the Current Biennium.
Expenditures: Base spending for the Current Biennium, including adjustments for expected inflation, was projected to be $55.494 billion, $1.536 billion (2.8%) more than November 2022 Forecast estimates. The majority of this increase was due to the addition of $1.423 billion in expected inflation, an estimate that law prohibited from inclusion when the November 2022 Forecast was released. Another $106 million in spending increases compared to the prior forecast was in the “all other” category and was largely due to the inclusion of debt service and other costs related to the rehabilitation and expansion of the State Office Building, which was approved by the Rules Committee for the Minnesota House of Representatives in December 2022. Compared to estimates for the Previous Biennium, total General Fund spending in the Current Biennium was projected to be $3.839 billion (3.6% annually) higher.
February 2023 Forecast expenditures also held an estimated $1.423 billion in the Current Biennium to account for the impact of future inflation on State services. Prior to the enactment of certain laws, the commissioner of Minnesota Department of Management and Budget was prohibited from including an estimate of inflation on State expenditures in the forecast, unless specified by another formula in law.
Reserves: The Budget Reserve Account balance in the Current Biennium was projected to be $2.852 billion, unchanged from the Previous Biennium and from prior estimates. The Cash Flow Account balance of $350 million was also unchanged from prior estimates. The Stadium Reserve Account was projected to end the Current Biennium with a balance of $678 million.
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2023 Legislative Session – Current Biennium
During the 2023 Legislative Session, the Legislature enacted significant revenue and expenditure measures in the General Fund for the Current Biennium. Legislation impacting revenue resulted in an estimated $1.958 billion (3.2%) reduction in projected revenue compared to February 2023 Forecast estimates and enacted appropriations added $14.024 billion (25.3%) to base spending estimates. The Cash Flow and Budget Reserve Accounts were unchanged from February 2023 Forecast estimates but the repayment of Minnesota Sports Facility Authority State Appropriation Bonds triggered the repeal of the Stadium Reserve Account which resulted in that account no longer reserving funds from the bottom line of the General Fund. After accounting for all changes after enactment of the budget, the Current Biennium is expected to end with a balance of $1.583 billion.
Revenues in Enacted Budget: The approved budget reflects changes in General Fund revenues from the February 2023 Forecast for the Current Biennium. Net General Fund Revenues total $58.818 billion, $1.958 billion lower than February 2023 Forecast estimates.
Reserves in Enacted Budget: The Budget Reserve Account balance in the Current Biennium at the end of the 2023 Legislative Session was projected to be $2.852 billion, unchanged from the Previous Biennium and from prior estimates. The Cash Flow Account balance of $350 million was also unchanged from prior estimates. The Stadium Reserve Account balance was $0 for the Current Biennium at the end of the 2023 Legislative Session. Legislation enacted included a provision that eliminated the Stadium Reserve Account after the Minnesota Sports Facility Authority State Appropriation Bonds were fully paid off. Payoff of the bonds in full was assumed in legislative tracking documents and the payoff occurred on June 26, 2023.
November 2023 Forecast – Current Biennium
With the November 2023 Forecast, the Minnesota budget and economic outlook was improved compared to estimates at the end of the 2023 Legislative Session. A General Fund budget surplus of $2.392 billion was projected for the Current Biennium. The $808 million gain over prior estimates was due to a higher than projected closing balance to the Previous Biennium and an increased revenue forecast compared to prior estimates, partially offset by an increased spending forecast.
Revenues: Total General Fund Revenue for the Current Biennium were forecast to be $59.655 billion, $837 million (1.4%) more than the end of 2023 Legislative Session estimates. Total tax revenues for the biennium were forecast to be $57.058 billion, $710 million (1.3%) above the prior estimate. The forecasts for Minnesota’s three largest tax types were higher than the end of 2023 Legislative Session estimates.
Expenditures: Total General Fund revenues for the Current Biennium were projected to be $70.515 billion, $837 million (1.4%) higher than previously forecast. Spending was higher than end of 2023 Legislative Session estimates across all major areas, with the exception of the cost of debt service on State capital projects.
Reserves: A Minnesota law directs the Minnesota Department of Management and Budget to allocate funds to the Budget Reserve Account when there is a positive November
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forecast balance and other provisions such as repaying accounting shifts and funds borrowed from other sources are fulfilled. With the November 2023 Forecast, allocations to the Budget Reserve Account were triggered and $61 million was allocated to the Budget Reserve Account compared to end of 2023 Legislative Session estimates. After these allocations, the balance of the Budget Reserve Account was $2.913 billion. The Cash Flow Account balance of $350 million was unchanged from prior estimates.
February 2024 Forecast – Current Biennium
With the February 2024 Forecast revisions to revenue and expenditure estimates, the forecast improved $1.343 billion for the Current Biennium leading to a revised projected General Fund surplus of $3.715 billion.
Revenues: Total General Fund revenues for the Current Biennium were forecast to be $60.997 billion, $1.343 billion (2.43%) more than the prior estimates. Total tax revenues for the Current Biennium were forecast to be $58.324 billion, $1.266 billion (2.2%) above the prior estimate. The forecasts for Minnesota’s three largest tax types were higher than prior estimates.
Expenditures: Spending estimates for the Current Biennium were similar in aggregate to the November 2023 Forecast. Total General Fund expenditures were projected to be $70.535 billion, $19 million (less than 0.1%) higher than previously forecast. Spending was marginally higher than the November 2023 Forecast estimates, primarily due to changes in E-12 education. Property tax aids and credits also contributed to this increase, with slight decreases in health and human services, debt service, and other spending partially offsetting the increase.
Reserves: The Budget Reserve Account balance remained at $2.913 billion. The Cash Flow Account remained at $350 million.
2024 Legislative Session – Current Biennium
The 2024 Legislature enacted laws that resulted in modest impacts on the State budget. At the end of the 2024 Legislative Session, General Fund revenue was expected to total $60.988 billion, $9 million (less than 0.1%) lower than prior estimates while spending was expected to total $70.950 billion, $415 million (0.6%) higher than February 2024 Forecast estimates. The significant carryforward from the Previous Biennium more than offsets the difference between spending and revenue leaving a projected surplus of $3.291 billion for the end of the Current Biennium.
Revenues: Revenue changes made by the 2024 Legislature were small, totaling a decrease of $8 million compared to the February 2024 Forecast. Revenue changes included a provision to fix a technical error related to corporate net operating losses from the 2023 Legislative Session and changes to definitions for tobacco products.
Expenditures: Spending changes enacted in the 2024 Legislative Session totaled $415 million (0.6%) in increased appropriations compared to the February 2024 Forecast. Major spending changes were $109 million to fund a legal settlement related to the Tyler v. Hennepin US Supreme Court decision, $98 million for health and human services programs and agencies, $47 million in adjustments to E-12 education appropriations, and $57 million for increases in
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public safety and the judiciary. Changes across all other areas of the State budget totaled $104 million for the Current Biennium.
Reserves: The Budget Reserve Account remained unchanged at $2.913 billion. The Cash Flow Account remained at $350 million.
Next Biennium
Planning estimates for the Next Biennium are based on the February 2024 Forecast adjusted for legislative action. The planning projections contain revenue and expenditure estimates for the Next Biennium based on the most recent information about the national and state economic outlook, caseloads, enrollments and cost projections as amended to reflect legislative enactment of the budget for the Current Biennium. The longer-term estimates for the Next Biennium carry a higher degree of uncertainty and a larger range of potential error.
Action taken during the 2024 Legislative Session had a small impact on revenue and spending in the Next Biennium. For revenues, legislative action resulted in $31 million more revenue than projected in the February 2024 Forecast. For spending, changes resulted in increased base level spending by $126 million compared to the February 2023 Forecast. Ongoing base level increases in the Next Biennium result from appropriation increases added in the Current Biennium.
General Fund revenues, including the impact of legislative changes, in the Next Biennium are estimated to be $64.845 billion, $3.857 billion (6.3%) higher than estimates for the Current Biennium. Projected base level spending, including the impact of legislative changes, in the Next Biennium is now estimated to be $66.418 billion, $4.532 billion (6.4%) lower than estimates for the Current Biennium. Spending projections include increases incorporated in current law to education aids, health care, and local aid/property tax relief programs based on enrollment, caseload and current law formula provisions. In addition, spending estimates include an aggregate inflationary adjustment of $845 million intended to represent the added cost of maintaining current service levels for programs that do not have inflationary growth built into their statutory funding formula. Inflation estimates, like base level spending estimates, are not yet appropriated for the Next Biennium; the 2025 Legislature will set legal appropriation levels for the Next Biennium.
The General Fund Budget Reserve Account and Cash Flow Account balances are not expected to change from the Current Biennium.
Litigation
There are now pending against the State certain legal actions that could, if determined adversely to the State, have a material adverse effect in excess of $15 million on the State’s expenditures or revenues during the Current Biennium.
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NEW JERSEY PORTFOLIO
The following is based on information obtained from Appendix I (Financial and Other Information Relating to the State of New Jersey) of an Official Statement, dated April 30, 2024, relating to the New Jersey Health Care Facilities Financing Authority $54,100,000 Lease Revenue Refunding Bonds, Series 2024, as well as the State of New Jersey Debt Report for Fiscal Year 2023, The State of New Jersey Governor’s Budget Message for Fiscal Year 2025, and the U.S. Bureau of Economic Analysis.
Economic Climate
The State of New Jersey (“New Jersey” or the “State”) is the eleventh largest state in population and the fifth smallest in land area. The population of New Jersey in 2023 was estimated to be 9,290,841 persons. With an average of 1,263 persons per square mile as of 2023, it is the most densely populated of all the states. Between 1980 and 1990 the annual population growth rate was 0.49% and between 1990 and 2000 the growth rate accelerated to 0.85%. While this rate of growth compared favorably with other Middle Atlantic States, it was less than the national rate of increase. The growth rate decreased to 0.44% between 2000 and 2010. New Jersey’s population has grown an average of 0.4% per year from 2010 to 2023. This is above the average annual growth rate of 0.1% for New York and 0.2% for Pennsylvania. It is below the national growth rate of 0.6%. The State is a part of a megalopolis that extends from Washington, D.C. in the south to Boston, Massachusetts in the north and includes about one-sixth of the nation’s population, making it an attractive location for businesses due to its central location and ability to access both regional and world markets. The extensive facilities of the Port Authority of New York and New Jersey, the Delaware River Port Authority and the South Jersey Port Corporation across the Delaware River from Philadelphia augment the air, land and water transportation complex that has influenced much of the State’s economy. This central location in the northeastern corridor, the transportation and port facilities and proximity to New York City make the State an attractive location for corporate headquarters and international business offices. A number of Fortune Magazine’s top 500 companies maintain headquarters or major facilities in New Jersey, and many foreign-owned firms have facilities located in the State.
The following industries are at the center of the State’s diverse economy: technology, transportation and logistics, health care, financial services, biopharmaceuticals, and advanced manufacturing. There is also a strong commercial agriculture sector in the rural areas. The Jersey Shore, part of the Atlantic Seaboard, is a focus of the Statoe’s tourism sector and includes casino gambling in Atlantic City.
According to the United States Commerce Department, Bureau of Economic Analysis, New Jersey’s real gross domestic product grew 1.5% in 2023, which was lower than the 2.5% national gross domestic product growth in 2022-2023. In 2023, New Jersey current-dollar gross domestic product was $799.306 billion, ranking tenth in the United States.
In 2023, New Jersey’s economy experienced stable growth. The State’s GDP showed moderate growth overall and employment levels continued to rise, surpassing pre-pandemic levels in most industries. Price inflation continued to decline over the course of the year. Higher interest rates, intended to tame inflation and slow economic activity, have plateaued
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since the summer of 2023, but continue to restrict economic activity in some sectors, most notably the housing market. As 2024 begins, the near-term economic outlook for the State and the nation is for continued moderate growth, with uncertainty relating to when the Federal Open Market Committee (“FOMC”) will start to lower interest rates and encourage spending and investment.
Despite a higher unemployment rate, New Jersey’s labor market proved resilient in 2023. Following two consecutive years of record jobs growth, another 89,600 jobs were added in 2023. Employment rose in ten out of twelve months in 2023, with positive job growth in each of the final five months of the year. This represented a sustained recovery from 2020, when employment fell by 302,100 net jobs, including an unprecedented initial decline of 726,300 jobs at the start of the pandemic in March and April 2020. Payroll employment grew by an average of 8,900 jobs per month over the first half of 2023 and grew by an average of 6,100 jobs per month over the second half of the year. By the end of the year, New Jersey had 148,600 more nonfarm jobs than prior to the COVID-19 pandemic, rising 3.5% from February 2020 to December 2023. This was higher than New York’s (-0.7%), Pennsylvania’s (0.5%), and Connecticut’s (-0.2%) recent employment levels compared to pre-pandemic levels.
The State’s unemployment rate increased a percentage point over the course of 2023, rising to 4.8% in December 2023 as the number of unemployed persons rose quicker than the labor force. This was 1.1% higher than the national rate (3.7%). New Jersey’s December 2022 labor force participation rate of 64.1% was 0.4% lower than the pre-pandemic level of 64.5%, but 1.3% higher than in December 2021. It was also higher than the unemployment rate of New York (4.6%), Pennsylvania (3.4%), and Connecticut (4.2%), and ranked third highest in the nation.
The housing market continued to slow from 2022 into 2023 amidst elevated mortgage interest rates and elevated home prices. The average U.S. 30-Year fixed rate mortgage in December 2023 hovered over 6.0%, double its 3.0% level in December 2021. The median sales price for a single-family home in New Jersey eclipsed $500,000 in 2023, rising 6.3% from 2022, when prices rose 8.7%. According to New Jersey Realtors data, existing-home sales started to weaken near the end of 2021 and total closed sales fell 17.8% in 2022, matching levels last seen in 2015. Sales continued to decline in 2023, matching levels not seen since 2012-2013 as both the inventory of homes for sale and the affordability index reached their lowest levels since at least 2010.
New Jersey wages and salaries rose 5.1% in 2023, and personal income in the State rose 4.9%. New Jersey’s wage and salary growth in 2023 was outpaced by Pennsylvania (5.5%), New York (5.8%), and the nation (6.3%). Overall, New Jersey’s wage and salary growth ranked third lowest of the fifty States. Personal income growth overall ranked 27th amongst the fifty States, still behind regional peer and national rates.
Price inflation continued its decline from the highs of 2022, as the U.S. Consumer Price Index (“CPI”) rose 3.2% year-over-year in February 2024, representing a decline of 2.9% from February 2023’s level of 6.0%. Core CPI, which excludes food and energy items, rose 3.8% year-over-year. Inflation in the metropolitan area containing much of northern and central New Jersey has generally been more subdued than national inflation, as regional year-over-year CPI
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growth 2.9% and regional core CPI was up 3.4% in February 2024. It is generally anticipated that the CPI will fall below 3.0% throughout 2024 and average in the mid-2% range for the year.
The economic outlook has brightened recently for both New Jersey and the United States, as interest rates are thought to have peaked and inflation continues to recede. Wage gains have struggled to keep up with the pace of inflation, which has dampened consumer spending. Members of the FOMC estimated real GDP in the nation to grow 2.1% in 2024 off of a surprisingly strong 2023 (estimates show U.S. GDP rose 2.5% in 2023), according to their March 2024 projection. Economists surveyed by the Wall Street Journal in January 2024 forecasted real GDP growth of 1.0% for the U.S. in 2024.
Certain Constitutional Provisions
The State Constitution provides, in part, that no money shall be drawn from the State Treasury but for appropriations made by law and that no law appropriating money for any State purpose shall be enacted if the appropriations contained therein, together with all prior appropriations made for the same fiscal period, shall exceed the total amount of the revenue on hand and anticipated to be available to meet such appropriations during such fiscal period, as certified by the Governor.
The State Constitution further provides, in part, that the State Legislature shall not, in any manner, create in any fiscal year a debt or liability of the State, which, together with any previous debts or liabilities, shall exceed at any time 1% of the total appropriations for such year, unless the same shall be authorized by a law for some single object or work distinctly specified therein. No such law shall take effect until it shall have been submitted to the people at a general election and approved by a majority of the legally qualified voters voting thereon; provided, however, no such voter approval is required for any such law authorizing the creation of a debt for a refinancing of all or any portion of the outstanding debts or liabilities of the State, so long as such refinancing shall produce a debt service savings.
The Debt Limitation Clause was amended by the voters on November 4, 2008. The amendment provides that the State Legislature is prohibited from enacting any law that creates or authorizes the creation of a debt or liability of an autonomous State corporate entity, which debt or liability has a pledge of an annual appropriation as the means to pay the principal of and interest on such debt or liability, unless a law authorizing the creation of that debt or liability for some single object or work distinctly specified therein shall have been submitted to the people and approved by a majority of the legally qualified voters of the State voting thereon at a general election.
State Projected Revenues and Expenditures
Revenues and expenditures for General State Funds (or “State Funds”) are classified as either budgeted or not budgeted. Budgeted State Funds include the five funds that comprise the State budget: General Fund, Property Tax Relief Fund, Casino Revenue Fund, Casino Control Fund and Gubernatorial Elections Fund. Other Governmental Funds account for other resources legally restricted to expenditure for specific purposes. The funds include general obligation bond funds, non-major special revenue funds and capital project funds. Proprietary
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funds are used to report any activity for which a fee is charged to external users for goods and services. Activities are required to be reported as proprietary funds if laws or regulations require that the activity’s cost of providing services be recovered with fees and charges. The Unemployment Insurance Fund is a proprietary fund.
According to the State of New Jersey Detailed Budget for the Fiscal Year of 2024, the Fund balance for All Funds, including General State Funds, Other Governmental Funds and Proprietary Funds was estimated at $28,816.8 million for Fiscal Year 2024, an increase of $3.6 million, or 0.01% over the Fiscal Year 2023 estimated balance of $28,813.2 million.
According to the State of New Jersey Detailed Budget for the Fiscal Year of 2025, the Fund balance for All Funds, including General State Funds, Governmental Funds, and the Proprietary Funds is estimated at $23.698 billion for Fiscal Year 2025, a decrease of $3.406 billion, or 12.6% less than the Fiscal Year 2024 estimated balance of $27.104 billion.
Recent Fiscal Years
In New Jersey and most other states, the pandemic and post-pandemic years saw substantial volatility in revenue collections. After an initial pandemic-induced revenue decline in Fiscal Year 2020, State revenues grew significantly in Fiscal Years 2021 and 2022, followed by a decline in overall revenue collections in Fiscal Year 2023. Revised Fiscal Year 2024 revenues are now projected to be relatively similar to Fiscal Year 2023, with a minimal projected 0.3% increase to $52.2 billion. The State’s substantial revenue growth from pre-pandemic levels has increased fund balances to historically high levels, including an undesignated fund balance of $10.5 billion as of June 30, 2023.
Fiscal Year 2024
The Fiscal Year 2024 Appropriations Act, along with enacted supplemental appropriations, appropriated, in aggregate, approximately $54.450 billion. These appropriations were mostly supported by certified State revenues for Fiscal Year 2024 of approximately $52.748 billion, but were also supported by a partial drawdown of the State’s fund balance of approximately $1.7 billion. The combined ending fund balance at that time was projected to be $8.255 billion. As of the time of the Governor’s Fiscal Year 2025 Budget Message, the State projects that revenues will be slightly lower than certified at $52.245 billion, and appropriations will be higher at $55.433 billion. Overall, for June 30, 2024, the State projects its combined ending fund balance will be approximately $8.160 billion.
Governor’s Fiscal Year 2025 Budget Message
In the Governor’s Fiscal Year 2025 Budget Message, the Governor’s revenue projection anticipates that revenues will grow to $54.1 billion, an increase in total revenues for Fiscal Year 2025 of about 3.6% when compared to Fiscal Year 2024. The State’s revenue forecast accounts for various risk factors related to the economic uncertainties facing the State and national economy, but generally assumes the consensus forecast of slow economic growth, which will therefore produce modest revenue growth. The Fiscal Year 2025 forecast includes the impact of the expiration of the 2.5% surtax of the Corporation Business Tax and assumes the
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enactment by the State Legislature of a Corporate Transit Fee, intended to sustain the economically vital commuter mass transit network run by New Jersey Transit. Overall, Fiscal Year 2025 revenue projections anticipate slow growth in personal income and consumer spending, moderating price inflation, and stabilization in the real estate market by the Spring of 2025.
The Governor’s Fiscal Year 2025 Budget Message recommends approximately $55.908 billion in appropriations. These appropriations are mostly supported by projected revenues for Fiscal Year 2025 of approximately $54.109 billion, but will also be supported by a partial drawdown of the State’s robust surplus of approximately $2 billion. The Fiscal Year 2025 Governor’s Budget Message projects an ending fund balance for the State as of June 30, 2025, of approximately $6.109 billion, which would represent a decline from the projected combined ending fund balance as of June 30, 2024, of approximately $8.160 billion.
Risk Factors Facing the State’s Financial Condition
While the State’s financial condition depends on a wide variety of economic, demographic, and policy factors, as the State generally monitors its revenues and expenditures, the State is particularly focused on the following aspects of its financial condition and potential risks:
· | The Governor’s Fiscal Year 2025 Budget Message contemplates that the State would drawdown approximately $2 billion from its fund balance. If adopted, this would represent the second consecutive year that the State has included a substantial drawdown in its fund balance and, if the budget assumptions were realized, would result in a reduction in fund balance from $10.5 billion to $6.109 billion in two fiscal years. While the State continues to enjoy a robust fund balance even with these drawdowns, if the State does not experience an increase in revenues the State may need to address a difference between its revenues and expenditures in future fiscal years to avoid further reductions in its fund balance. |
· | The State’s revenues rely, to some extent, on high-income taxpayers who generate wage and non-wage income through certain types of business income and the financial markets. The State experienced a decline in gross income tax collections of $1.9 billion in Fiscal Year 2023 compared to Fiscal Year 2022. This was primarily attributable to income tax collections from certain high-income sources such as capital gains realizations falling substantially and also the impact of credits utilized by taxpayers of the pass-through business alternative income tax. A further small decline in gross income tax collections of approximately $89.3 million is now forecasted for Fiscal Year 2024. If financial markets continue to encounter volatility and disruption, State revenues in Fiscal Year 2025 may be adversely affected in contrast to the revenue surges experienced in prior years. |
· | Due to federal law, states have not been permitted over the past several years to disenroll beneficiaries from the Medicaid program. Under the provisions of the Fiscal Year 2023 omnibus bill, states began the eligibility review process as of April 1, 2023. Due to administrative burdens, the federal government issued guidance |
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permitting states to temporarily delay disenrolling Medicaid beneficiaries. New Jersey began to realize the initial impacts of these redeterminations in August 2023. The Fiscal Year 2024 Appropriations Act assumes a pace of disenrollments based on historical trends, and that overall Medicaid enrollment will decline to an average of 1.913 million beneficiaries per month in Fiscal Year 2025. However, if the pace of disenrollments for the remaining months of Fiscal Year 2024 do not come to fruition, the enrollments and budgeted funding in Fiscal Year 2025 could be insufficient to support the costs of the Medicaid program.
· | The Medicaid program in New Jersey, NJ FamilyCare, provides monthly capitation payments to the Managed Care Organizations (“MCOs”) that oversee the healthcare of over 95% of Medicaid beneficiaries. The monthly rates paid to the MCOs are determined based on a review of costs, and other factors, and are increased annually based on recommendations by the State’s Medicaid actuary. The recommended rate increases will not be available until April 2024. It is possible that the State’s assumption of cost increases could be low, which could result in additional State costs for the Medicaid program in Fiscal Year 2025. |
· | L. 2019, c. 120 revised the statute of limitations for minor victims and adult victims of sexual abuse and removed the procedural temporal bar of the New Jersey Tort Claims Act as a bar to bringing claims for injuries resulting from sexual abuse against public entities. This legislative change has resulted in a large amount of cases being brought, particularly by minor victims of sexual abuse, that, prior to the enactment of L. 2019, c. 120, would have been barred. As a result, the State projects that it will face an increased amount of liability for monetary damages beyond what is currently budgeted. While the State will vigorously defend itself in these matters, the State is unable to predict the amount of its potential liability exposure. However, as these cases are resolved, it is unlikely that the State’s combined fund balance will be impacted in Fiscal Years 2025 and 2026. |
State Indebtedness
As of June 30, 2023, New Jersey’s outstanding long-term obligations for governmental activities totaled approximately $159.2 billion, a $9.4 billion decrease over the prior fiscal year. Of the $9.4 billion decrease, $13.9 billion is attributable to decreases in OPEB Liability and $93.8 billion to Leases/SBITAs. Additionally, there was a decrease of $2.4 billion in bonded debt and a decrease of $9.4 billion in total non-bonded debt. Long-term bonded obligations totaled $41.5 billion, while other long-term obligations totaled $159.2 billion. In addition, the State has $8.5 billion of legislatively authorized bonding capacity that has not yet been issued. As of June 30, 2023, the legislatively authorized but unissued debt decreased by $0.8 billion from the prior fiscal year.
State Authorities
The State has entered into a number of leases and contracts, some of which are described below, with several governmental authorities to secure the financing of various State
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projects. Under the agreements, the State has agreed to make payments equal to the debt services on, and other costs related to, the obligations sold to finance the projects.
Legislation enacted in 1992 by the State authorizes the New Jersey Sports and Exposition Authority (“NJSEA”) to issue bonds for various purposes, related to sports and entertainment facilities, payable from State appropriations. Pursuant to this legislation, the NJSEA and the State Treasurer have entered into an agreement (the “NJSEA State Contract”) pursuant to which the NJSEA will undertake certain projects, including the refunding of certain outstanding bonds of the NJSEA, and the State Treasurer will credit to the NJSEA amounts from the General Fund sufficient to pay debt service and other costs related to the bonds. The payment of all amounts under the NJSEA State Contract is subject to appropriation by the State Legislature. As of June 30, 2023, there were approximately $54,250,000 aggregate principal amount of NJSEA bonds outstanding, the debt service on which is payable from amounts credited to the NJSEA Fund pursuant to the State Contract.
The Transportation Trust Fund Authority (“TTFA”) was created in 1984 to provide a funding mechanism, including the issuance of bonds, for transportation system improvements undertaken by the New Jersey Department of Transportation. Pursuant to the TTFA Act, as amended in June 2012, the principal amount of the TTFA’s bonds, notes or other obligations which may be issued in any fiscal year generally may not exceed $1,247,000,000 for the Fiscal Year beginning July 1, 2012, $849,200,000 for the Fiscal Year beginning July 1, 2013, $735,300,000 for the Fiscal Year beginning July 1, 2014, and $626,800,000 for the Fiscal Year beginning July 1, 2015, except that if the permitted amount of debt, or any portion thereof, is not incurred in a fiscal year, it may be issued in a subsequent fiscal year. These bonds issued by the TTFA are special obligations of the TTFA payable from a contract among the TTFA, the State Treasurer and the Commissioner of Transportation, subject to appropriation by the State Legislature. As of June 30, 2023, there were approximately $7,447,380,000 aggregate principal amount of TTFA Transportation Program Bonds outstanding. A 2016 amendment of the TTFA Act authorizes the issuance of $12 billion in Transportation Program Bonds between Fiscal Year 2017 and Fiscal Year 2024, the payment of debt service on which must be paid solely from revenues dedicated for transportation purposes pursuant to Article VIII, Section II, paragraph 4 of the State Constitution. An amendment to Article VIII, section II, paragraph 4 of the State Constitution was approved by the voters on November 8, 2016, dedicating all revenue from the motor fuels and petroleum products gross receipts taxes for transportation purposes. These constitutionally dedicated monies are available to be appropriated by the Legislature to the TTFA to pay debt service on Transportation Program Bonds issued by the TTFA and as pay-as-you-go-funding.
Pursuant to legislation enacted in 1996, the New Jersey Economic Development Authority (the “NJEDA”) has been authorized to issue bonds for various purposes, including Economic Recovery Bonds, State Pension Funding Bonds and Market Transition Facility Bonds. Economic Recovery Bonds had been issued pursuant to legislation enacted in 1992 to finance various economic development purposes. Pursuant to that legislation, NJEDA and the State Treasurer entered into an agreement (the “ERF Contract”) through which NJEDA agreed to undertake the financing of certain projects and the State Treasurer agreed to credit to the Economic Recovery Fund from the General Fund amounts equivalent to payments due to the State under an agreement with the Port Authority of New York and New Jersey. The payment of
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all amounts under the ERF Contract was subject to and dependent upon appropriations being made by the State Legislature.
Legislation enacted in June 1997 authorized the NJEDA to issue bonds to pay a portion of the State’s unfunded accrued pension liability for the State’s retirement systems (the “Unfunded Accrued Pension Liability”), which, together with amounts derived from the revaluation of pension assets pursuant to companion legislation enacted at the same time, are sufficient to fully fund the Unfunded Accrued Pension Liability. As of June 30, 2023, there were approximately $1,765,690,700 aggregate principal amount of State Pension Funding Bonds outstanding. The EDA and the State Treasurer entered into an agreement that provided for the payment to the EDA of monies sufficient to pay debt service on the bonds. Such payments were subject to and dependent upon appropriations being made by the State Legislature.
The authorizing legislation for certain State entities provides for specific budgetary procedures with respect to certain obligations issued by such entities. Pursuant to such legislation, a designated official is required to certify any deficiency in a debt service reserve fund maintained to meet payments of principal of and interest on the obligations, and a State appropriation in the amount of the deficiency is to be made. However, the State Legislature is not legally bound to make such an appropriation. Bonds issued pursuant to authorizing legislation of this type are sometimes referred to as moral obligation bonds. There is no statutory limitation on the amount of moral obligation bonds which may be issued by eligible State entities. Moral obligation bonded indebtedness issued by State entities as of June 30, 2016 stood at an aggregate principal amount of $2,555,000,000. Of this total, $6,395,000 was issued by the New Jersey Housing and Mortgage Finance Agency. Currently, no moral obligation bonds of the New Jersey Housing and Mortgage Finance Agency are outstanding. As of June 30, 2023, there were approximately $170,960,000 senior moral obligation bonds and $255,000,000 subordinate moral obligation bonds outstanding, for an aggregate principal amount of $425,960,000 of South Jersey Port Corporation moral obligation indebtedness outstanding. The moral obligation bonds of the Higher Education Student Assistance Authority are secured by student loans, the revenues for which have always been sufficient to pay debt service. Thus, the debt service reserve fund has not been drawn upon, and the moral obligation has not been exercised. The State, when necessary, provides the South Jersey Port Corporation with funds to cover all debt service and property tax requirements when the Corporation’s earned revenues are anticipated to be insufficient to cover these obligations.
Litigation
At any given time, there are various numbers of claims and cases pending against the State, State agencies and employees, seeking recovery of monetary damages that are primarily paid out of the fund created pursuant to the New Jersey Tort Claims Act. The State does not formally estimate its reserve representing potential exposure for these claims and cases. The State is unable to estimate its exposure for these claims and cases.
OHIO PORTFOLIO
The following is based on information obtained from an Official Statement, dated March 12, 2024, relating to $173,970,000 State of Ohio Infrastructure Improvement General
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Obligation Bonds, Series 2024A, as well as data from the U.S. Bureau of Economic Analysis and the U.S. Bureau of Labor Statistics.
Economic Climate
The 2020 decennial census population of 11,797,517 of the State of Ohio (“Ohio” or the “State”) indicated a 2.3% population growth since 2010 and ranked Ohio seventh among the states in population.
Although manufacturing (including auto-related manufacturing) in Ohio remains an integral part of the State’s economy, the greatest growth in Ohio’s economy in recent years has been in the non-manufacturing sectors. Ohio’s 2022 economic output, as measured by gross state product (“GSP”), totaled $822.7 billion, 3.20% of the national GDP and seventh largest among the states. The State ranks fourth within the manufacturing sector ($129.4 billion) and fifth in durable goods ($68.3 billion). As a percentage of Ohio’s 2022 GSP, 15.7% was attributable to manufacturing, with 23% attributable to the goods-producing sectors and 33.6% to the business services sectors, including finance, insurance and real estate. Ohio is the ninth largest exporting state with 2022 merchandise exports totaling $56.4 billion. The State’s leading export products are machinery (including electrical machinery), motor vehicles (including parts), aircraft/spacecraft and plastics, which together accounted for more than half of the total.
Non-farm payroll employment in Ohio, in a diversifying employment base, decreased in 2001 through 2003, increased in 2004 through 2006, decreased in 2007 through 2010, and increased in 2011 through 2022. In the last three decades, there has been a shift toward the services industry, with manufacturing employment decreasing since its 1969 peak. The “non-manufacturing” sector employs approximately 87.7% of all non-farm payroll workers in Ohio.
With 13.5 million acres (of a total land area of 26.4 million acres) in farmland and an estimated 77,800 individual farms, agriculture and related sectors are an important segment of Ohio’s economy. Ohio’s 2022 crop production value of $9.2 billion ranked ninth among states and represented 3.3% of the U.S. total value. Ohio’s 2022 livestock production value of $6.2 billion ranked seventeenth among states and represented 2.4% of the U.S. total value. As of 2022, Ohio accounts for 4.2% of total U.S. cash receipts for corn and 6.9% for soybeans. In 2022, Ohio’s agricultural sector output (consisting of crops, livestock, poultry, dairy, services and forestry, and all farm-related income) totaled $15.4 billion and represented 2.9% of the U.S. total value. Ohio farm expenses and purchased inputs (feed, seed, chemicals, fertilizer, livestock, utilities, labor, and machinery) totaled $9.8 billion. The net farm income on Ohio farms in 2022 was $6.6 billion.
The COVID-19 pandemic is altering the behavior of businesses and people in a manner that is expected to have negative effects on global and local economies, including the State. In response to the public health crisis, Governor DeWine and the Director of the Ohio Department of Health issued a declaration of a state of emergency on March 9, 2020 and rescinded the order, thereby ending the state-declared public health emergency on June 17, 2021. As of December 2023, the State’s unemployment rate was 3.7% which is 0.3% lower than the State’s unemployment rate of 4.0% in 2022.
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Financial Condition
Consistent with the constitutional provision that no appropriation may be made for a period longer than two years, the State operates on the basis of a fiscal biennium for its appropriations and expenditures. The Constitution requires the General Assembly to provide for raising revenue, sufficient to defray the expenses of the State, for each year, and also a sufficient sum to pay the principal and interest as they become due on the State debt. The State is effectively precluded by law from ending a fiscal year or a biennium in a deficit position. State borrowing to meet casual deficits or failures in revenues or to meet expenses not otherwise provided for is limited by the Constitution to $750,000.
The GRF is the largest fund of the State. Personal income and sales and use taxes are the major sources of GRF tax revenue. The last complete Fiscal Year ended June 30, 2023, with an unobligated GRF fund balance of $7.357 billion. The State has a “rainy day” fund, the Budget Stabilization Fund (“BSF”), which by law is intended to carry a balance of up to 10% of the GRF revenue for the preceding fiscal year. The BSF balance as of August 1, 2023, was $3.65 billion (includes $150 million of transfers), which equals 8.6% of Fiscal Year 2023 GRF revenue.
At present the State itself does not levy ad valorem taxes on real or tangible personal property. Those taxes are levied by political subdivisions and local taxing districts. The Constitution has, since 1934, limited the amount of the aggregate levy of ad valorem property taxes, without a vote of the electors or municipal charter provision, to 1.0% of true value in money, and statutes limit the amount of the aggregate levy without a vote or charter provision to 10 mills per $1 of assessed valuation – commonly referred to in the context of Ohio local government finance as the “ten-mill limitation.”
The Constitution directs or restricts the use of certain revenues. Highway fees and excises, including gasoline taxes, are limited in use to highway-related purposes. Not less than 50% of the receipts from State income taxes must be returned to the originating political subdivisions and school districts. State lottery net profits are allocated to elementary, secondary, vocational and special education program purposes, including application to debt service on obligations issued to finance capital facilities for a system of common schools.
2022-2023 Recent Biennium
Consistent with State law, the Governor’s Executive Budget for the 2022-23 fiscal biennium was released on February 1, 2021 and introduced in the General Assembly. After extended hearings and review, the 2022-23 biennial appropriations Act was passed by the General Assembly and signed by the Governor (with selective vetoes) into law on June 30, 2021. The Act provided for GRF Appropriations reflecting tax law changes and a conservative underlying economic forecast.
GRF Appropriations are $34.9 billion for Fiscal Year 2022 and $39.3 billion for Fiscal Year 2023. When combined together, this totals $74.3 billion in 2022-23 Biennium GRF Appropriations.
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The 2022-23 biennial apparitions Act revised the school funding formula to consider resident income levels in addition to property tax values. The Act also authorized the BSF to retain interest earnings. The 2022-23 Biennium Total GRF Revenue is estimated to be $76.6 billion.
On January 21, 2022, Governor Mike DeWine announced Intel Corporation plans to invest $20 billion to construct a new semiconductor manufacturing plant in Ohio for which the State plans to commit $691 million for State and local infrastructure improvement, $600 million for onshoring incentive grants, and an estimated $650 million 30-year job creation tax credit. Incentives included performance benchmarks allowing the State to recover proceeds disbursed should the company fail to meet contracted obligations. The State’s assistance is from available resources and not funded by debt proceeds. The positive impact of this development on Ohio is expected to lead to 20,000 additional jobs.
The State ended Fiscal Year 2023 with GRF cash and fund balances of $8.99 billion and $7.36 billion, respectively. As Authorized in the 2024-2025 budget bill, the entire fund balance was carried forward into Fiscal Year 2024, including $212.6 million reserved to maintain the statutory target of one-half of one percent of Fiscal Year 2023 GRF revenues. The Fiscal Year 2024-2025 budget bill also included several FY 2023 ending balance transfers including $741 million to the Expanded Sales Tax Holiday fund, $700 million to the One-Time Strategic Community Investments Fund, and $667 million to the All Ohio Future Fund.
Fiscal Year 2023 GRF tax revenues were greater than both the original forecast derived in July 2021 for the enacted Fiscal Year 2022-2023 operating budget as well as the updated forecast issued in August 2022. Tax revenues for the fiscal year were 994.2 million above the updated forecast. This variance was driven by the personal income tax, which was $645.1 million above estimate in fiscal year 2023. In addition, sales and use taxes were $149.2 million above estimate, and the commercial activity tax outperformed the estimate by $82.9 million.
The 2022-2023 biennial appropriations Act reflected certain tax policy and allocation changes, resulting in an estimated net GRF revenue decrease of $1 billion in Fiscal Year 2022 and $977 million in Fiscal Year 2023. The appropriations Act, among other things, effects an across-the-board 3.0% reduction in State personal income tax rates on non-business income, except for consolidating the top two income brackets and setting the new top rate at 3.99%, and contains a one-year suspension of income bracket indexing (effective tax year 2021) and a two-year suspension of personal exemption indexing (tax years 2021 and 2022). The tax bracket changes eliminated any tax liability for individuals with taxable income less than $25,000.
Municipalities, school districts, and joint economic development districts and zones may also levy certain income taxes. Any municipal rate (applying generally to wages and salaries, and net business income) over 1.0%, and any school district income tax (applying generally to the State income tax base for individuals and estates), requires voter approval. Most cities and villages levy a municipal income tax. The highest municipal rate in 2020 was 3.0%. A school district income tax is currently approved in 210 districts. Each joint economic development district or zone may also levy an income tax (which like municipal income taxes
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applies generally to wages and salaries and business net income) with the rate of that tax limited to the highest income tax rate of a municipal member of the district or zone. Effective July 1, 2005, there may also be proposed for voter approval municipal income taxes to be shared with school districts, but these taxes may not be levied on non-residents.
Since 1970 the ratio of Ohio to U.S. aggregate personal income has declined, with Ohio’s ranking moving from fifth among the states in 1970 to seventh in 1990, and eighth since 2000. This movement in significant measure reflects “catching up” by several other states and a trend in Ohio toward more service sector employment.
Outbreak of Covid-19
To balance the State budget in Fiscal Year 2020 (due to anticipated declines in revenue and increased costs relating to the State’s response to the COVID-19 pandemic), Governor DeWine directed spending cuts of approximately $775 million for the remainder of Fiscal Year 2020. The cuts include the following reductions: $210 million in Medicaid spending; $300 million in K-12 education spending; $110 million in higher education spending; $55 million in other education spending; and $100 million in other state agencies and programs spending. The State also continued the previously announced hiring freezes, travel limitations, and contracting restrictions.
Initial revised Fiscal Year 2021 revenue projections indicated that available State revenue receipts and balances in the GRF were projected to be $36.0 billion, approximately $2.43 billion less than originally estimated (and $200 million less than the reserve held in the BSF). In response to those updated revenue projections for Fiscal Year 2021 and in addition to the budgetary controls already in place, OBM and the Department of Administrative Services (“DAS”) implemented cost savings measures to further reduce expenditures by state agencies, boards, and commissions including continuing employment-related freezes and mandatory cost savings programs for exempt employees for FY 2021. On March 25, 2021, DAS rescinded the order that froze all exempt employee pay rates and step increases effective with the pay period beginning April 11, 2021.
On January 22, 2021, Governor DeWine signed an executive order formally finalizing the Fiscal Year 2021 budget reductions at $390 million across all agencies. Because this reduction was less than the previously anticipated cuts, the Governor authorized the Department of Education to allot an additional $160 million and the Department of Higher Education to allot an additional $100 million of enacted Fiscal Year 2021 GRF appropriations previously withheld.
Under the American Rescue Plan Act of 2021 (“ARPA”), the federal government allocated approximately $10.7 billion to Ohio’s state and local governments with an additional $268.6 million allocated specifically for use in state capital projects to continue efforts to mitigate the fiscal effects stemming from COVID-19.
In the initial months of the COVID-19 pandemic, unemployment insurance claims increased significantly from an average of 7,915 claims per week during the first 11 weeks of 2020 to 274,288 during the week ending March 28, 2020. Between January and June 2020,
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Ohio’s Unemployment Trust Fund balance dropped from $1.26 billion to zero. On June 16, 2020, Ohio received an advance from the federal government to continue to pay the increased unemployment insurance claims. On September 3, 2021, Ohio paid off its $1.47 billion loan using ARPA funds.
Like other states, Ohio is aware of and is investigating allegations of overpayment or fraud with respect to unemployment claims and will pursue repayment where warranted. Such potential overpayment or fraud, and repayment thereof, will have no material effect on the State’s ability to pay debt service on its bonded indebtedness. The State has improved preventative safeguards to limit overpayments or fraudulent payments of unemployment compensation.
2024-2025 Current Biennium
The 135th General Assembly passed and the Governor signed four bills that provide appropriations to operate State government through fiscal years 2024 and 2025. The FY 2024-2025 biennial budget was conservatively crafted with several transfers from the GRF to use one-time resources for one-time investments. Estimated FY 2024 transfers from the GRF total $5.6 billion, including $667 million for the All Ohio Future Fund and $700 million for the One Time Strategic Community Investments Fund.
GRF Appropriations are $41.5 billion for Fiscal Year 2024 and $44.8 billion for Fiscal Year 2025, combined together this totals $86.2 billion in 2024-2025 Biennium GRF Appropriations.
The 2024-2025 biennial budget includes the following tax policy changes, among others:
· | The number of businesses subject to the commercial activities tax will be dramatically reduced by 90 percent by excluding up to $3 million in gross receipts per business in 2024 and up to $6 million in gross receipts per business in 2025. |
· | The sports gaming tax rate increases to 20 percent with proceeds dedicated to the school funding formula. |
· | Personal income tax reductions in the budget will reduce the number of personal income tax brackets. By 2024, the state personal income tax will have two rate brackets (one consisting of taxable income between $26,051 and $100,000, and the other consisting of income above $100,000), with marginal tax rates of 2.75 percent and 3.5 percent, respectively. There remains no tax liability if taxable income is $26,050 or below. |
· | A new expanded sales tax holiday will use surplus revenue to provide tax relief to consumers in August 2024 and future years if tax receipts exceed budgeted estimates. |
Fiscal year 2023 ended the fiscal year with the largest GRF cash balance in Ohio history. The Budget Stabilization Fund is at an all-time high and House Bill 33 raised the cap on the balance of the Budget Stabilization Fund to 10 percent of the GRF, allowing the fund to continue to grow. The FY 2024 biennial budget is balanced. As noted above, the State is
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effectively precluded by its Constitution from ending a fiscal year or a biennium in a “deficit” position. OBM continually monitors and analyzes revenues, expenditures, and related developments and prepares a detailed Monthly Financial Report, for full transparency of financial position.
Municipalities
Ohio has a mixture of urban and rural population, with approximately three-quarters urban. There are 926 incorporated cities and villages (municipalities with populations under 5,000) in the State. Six cities have populations of more than 100,000 and 18 cities exceed 50,000.
A 1979 act established procedures for identifying and assisting those few cities and villages experiencing defined “fiscal emergencies”. A commission composed of State and local officials, and private sector members experienced in business and finance appointed by the Governor, is to monitor the fiscal affairs of a municipality facing substantial financial problems. That act requires the municipality to develop, subject to approval and monitoring by its commission, a financial plan to eliminate deficits and cure any defaults and otherwise remedy fiscal emergency conditions, and to take other actions required under its financial plan. It also provides enhanced protection for the municipality’s bonds and notes and, subject to the act’s stated standards and controls, permits the State to purchase limited amounts of the municipality’s short-term obligations (used only once, in 1980).
The number of distributions to most local governments, including municipalities, from the several state local government revenue assistance funds have been subject to reductions and other adjustments in several of those recent biennia. The fiscal emergency legislation has been amended to extend its potential application to all Ohio counties and townships. This extension is on an “if and as needed” basis and is not aimed at particularly identified existing fiscal problems of those subdivisions. A current listing of governments in each status can be found on the Auditor of State’s website at http://www.auditor.state.oh.us.
Litigation
The State of Ohio is a party to various legal proceedings seeking damages or injunctive relief and generally incidental to its operations. The ultimate disposition of these proceedings is not presently determinable, but in the opinion of the Ohio Attorney General will not have a material adverse effect on payment of State obligations.
PENNSYLVANIA PORTFOLIO
The following was obtained from the Commonwealth of Pennsylvania Annual Comprehensive Financial Report for the Fiscal Year ended June 30, 2023, the 2024-2025 Governor’s Executive Budget, an Official Statement, dated December 6, 2023, relating to the issuance of $1,335,000,000 Commonwealth of Pennsylvania General Obligation Bonds, First Series of 2023 and $753,615,000 First Refunding Series of 2023, as well as data from the U.S. Bureau of Labor Statistics and the U.S. Bureau of Economic Analysis.
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Economic Climate
The Commonwealth of Pennsylvania (“Pennsylvania” or the “Commonwealth”) is one of the nation’s most populous states, ranking fifth behind California, Texas, Florida and New York. Pennsylvania stakes claim to a diverse economy and many thriving industries. At different times throughout its history, the Commonwealth has been the nation’s principal producer of ships, iron, chemicals, lumber, oil, textiles, glass, coal and steel. This led Pennsylvania to be identified, historically, as a heavy industrial state. That reputation has changed over the last several decades as the coal, steel and railroad industries have declined. The Commonwealth’s business environment readjusted with a more diversified economic base. Currently, the major sources of growth in Pennsylvania are in the service sector, including healthcare, leisure-hospitality, transport and storage.
However, development of natural gas continues to be one of the biggest factors in Pennsylvania’s economic outlook. Although direct employment in natural resources and mining is a small part of total jobs in the Commonwealth, its rapidly rising location quotient helps to illustrate the growth seen in the last few years. More important to the economy at all levels are the related jobs created in other sectors, such as construction, transportation, and professional services. Commonwealth manufacturers have already benefitted from demand for steel and equipment being used to drill the wells and get them connected to demand centers via pipelines. Pennsylvania’s competitiveness in manufacturing should be enhanced by the decreased costs of energy and petrochemical feedstocks coming from beneath the Commonwealth.
The Commonwealth’s manufacturing sector may not be what it was during the heydays of Pittsburgh’s dominance in the steel industry and Philadelphia’s claim to be “Workshop of the World,” but the Commonwealth’s share of manufacturing employment remains above the national average. Output of pharmaceuticals remains an engine of growth, while the rapid increase in the Commonwealth’s production of natural gas liquids provides the basis for gains in production of chemicals and plastics. Employment in the Commonwealth’s manufacturing sector will gradually increase over the next two years but remain below the pre-pandemic level.
Professional, scientific, and technical services will continue to be a bright spot for the Commonwealth in terms of job growth and economic output gains. High-tech fields such as artificial intelligence, industrial automation, and biosciences will see the most growth, while more traditional fields such as legal services will see more moderate gains. The Commonwealth’s healthcare and social service sector will continue to be a reliable source of job gains, but overall growth may be slower than in years past. Gains will be focused in the large metro areas, while smaller towns and rural areas feel the effects of low (or negative) population growth and fewer available services.
Finally, the Commonwealth’s geographic location makes it a prime corridor for the transportation of goods. From its extensive rail service and ports to its grid of interstate highways, Pennsylvania remains an integral part of the northeast region’s economic activity.
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The Commonwealth is highly urbanized. The largest Metropolitan Statistical Areas (“MSAs”) in the Commonwealth are those that include the cities of Philadelphia and Pittsburgh, which together contain the majority of the Commonwealth’s total population. The population of Pennsylvania, 12.9 million people in calendar year 2022, according to the U.S. Bureau of the Census, represents a population growing slower than the nation with a higher portion than the nation or the Middle Atlantic region comprised of persons 45 or over.
Non-agricultural employment in Pennsylvania increased in 2018 and 2019 before decreasing in 2020. Non-agricultural employment then increased in 2021 and 2022 throughout the Middle Atlantic Region and the entire United States.
Manufacturing employment in Pennsylvania has increased in 2022 and reached 91% of total non-agricultural employment. Consequently, manufacturing employment constitutes a diminished share of total employment within the Commonwealth. Manufacturing, contributing 9% of 2022 non-agricultural employment, has fallen behind the services sector, the trade sector and the government sector as the 4th largest single source of employment within the Commonwealth. In 2022, the services sector accounted for 50% of all non-agricultural employment while the trade sector accounted for 14%.
Within the manufacturing sector of Pennsylvania’s economy, which now accounts for about one-tenth of total non-agricultural employment in Pennsylvania, the fabricated metals industries employed the largest number of workers in 2022. Employment in the fabricated metals industries is 13.6% of Pennsylvania manufacturing employment but only 1.4% of total Pennsylvania non-agricultural employment in 2022.
As of May 2024, Pennsylvania had an unemployment rate of 3.4%., a significant decrease from an unemployment rate of 13% during the COVID-19 pandemic.
Personal income in the Commonwealth for 2023 was $879.3 billion. This personal income ranked sixth in the United States. In 2023, per capita personal income was of $67,839 in the Commonwealth compared to per capita personal income in the United States of $68,531.
Financial Condition
The Commonwealth utilizes the fund method of accounting. The General Fund, the Commonwealth’s largest operating fund, receives all tax revenues, non-tax revenues and federal grants and entitlements that are not specified by law to be deposited elsewhere. Most of the Commonwealth’s operating and administrative expenses are payable from the General Fund. Debt service on all bond indebtedness of the Commonwealth, except that issued for highway purposes or for the benefit of other special revenue funds, is payable from the General Fund.
Financial information for the General Fund is maintained on a budgetary basis of accounting. The Commonwealth also prepares annual financial statements in accordance with generally accepted accounting principles (“GAAP”). Annual financial statements prepared in accordance with GAAP are audited jointly by the Department of the Auditor General and an independent public accounting firm.
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Financial Results for Recent Fiscal Years (Budgetary Basis)
Fiscal Year 2023 (Preliminary, unaudited). General Fund revenues of the Commonwealth were above the certified estimate by $1,337.5 million or 3.1% during Fiscal Year 2023. Final Commonwealth General Fund revenues for the fiscal year totaled $44,917.1 million. Total expenditures, net of appropriation lapses and including public health and human services assessments and expenditures from additional sources were $40,801.0 million. After accounting for a Fiscal Year 2023 beginning balance of $5,546.4 million, and a transfer to the Budget Stabilization Reserve Fund, the Commonwealth ended Fiscal Year 2023 with a surplus of $8,084.9 million.
General Fund revenues decreased $3,217.1 million or 6.7% during fiscal year 2023 when measured on a year-over-year basis as compared to Fiscal Year 2022. Tax revenue collections increased $287.8 million or 0.7% on a year-over-year basis from Fiscal Year 2022 to Fiscal Year 2023 while non-tax revenue collections decreased $3,504.8 million or 75.4% from Fiscal Year 2022 to Fiscal Year 2023. The year over-year increase in corporate taxes was 12.8% during Fiscal Year 2023. Corporate net income tax collections increased 15.3% or by $815.5 million from 2022 levels.
Fiscal Year 2022. General Fund revenues of the Commonwealth were above the certified estimate by $5,598.0 million during Fiscal Year 2022. Final Commonwealth General Fund revenues for the fiscal year totaled $48,134.2 million. Total expenditures, net of appropriation lapses and including public health and human services assessments and expenditures from additional sources, were $39,351.3 million. After accounting for a fiscal year 2022 beginning balance of $4.4 million, and a transfer to the Budget Stabilization Reserve Fund, the Commonwealth ended Fiscal Year 2022 with a surplus of $5,537.4 million.
General Fund revenues increased $7,742.2 million or 19.2% during fiscal year 2022 when measured on a year-over-year basis as compared to fiscal year 2021. Tax revenue collections increased $4,309.0 million or 11.0% on a year-over-year basis from fiscal year 2021 to fiscal year 2022 while nontax revenue collections increased $3,433.2 million or 283.2% from fiscal year 2021 to fiscal year 2022, due primarily to the one-time transfer of federal ARPA funds to the General Fund as revenue replacement. The year-over-year increase in corporate taxes was 15.5% during fiscal year 2022. Corporate net income tax collections increased 20.2% or by $895.4 million from 2021 levels.
Fiscal Year 2021. General Fund revenues of the Commonwealth were above the certified estimate by $3,437.3 million (9.3%) during Fiscal Year 2021. Final Commonwealth General Fund revenues for the fiscal year totaled $40,392.0 million. Total expenditures, net of appropriation lapses and including public health and human services assessments and expenditures from additional sources, were $34,013.2 million. After accounting for a negative Fiscal Year 2021 beginning balance of $2,734.0 million, the Commonwealth ended Fiscal Year 2021 with a surplus of $2,621.5 million and transferred the surplus to the Budget Stabilization Fund.
General Fund revenues increased $8,116.1 million (25.1%) during Fiscal Year 2021 when measured on a year-over-year basis as compared to Fiscal Year 2020. Tax revenue
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collections increased $7,568.7 million (23.9%) on a year-over-year basis from Fiscal Year 2020 to Fiscal Year 2021 while non-tax revenue collections increased $547.4 million (82.3%) from Fiscal Year 2020 to Fiscal Year 2021. Corporate tax receipts were $1,494.5 million higher than Fiscal Year 2020 levels.
Financial Results for Recent Fiscal Years (GAAP Basis)
Fiscal Year 2022. At June 30, 2022, the General Fund reported a fund balance of $13,371.2 million, an increase of $10,298.2 million from the $3,073.0 million fund balance at June 30, 2021 as revenues and other sources increased by $15,929.7 million.
Fiscal Year 2021. At June 30, 2021, the General Fund reported a fund balance of $3,073.0 million, an increase of $4,598.5 million from the $1,525.4 million negative fund balance, as restated at June 30, 2020.
Fiscal Year 2024 Budget
The Pennsylvania legislature approved, and the Governor signed, a budget for Fiscal Year 2024 on August 3, 2023. The enacted budget appropriates $44,947.3 million from the Commonwealth’s General Fund (hereinafter the “General Fund” as described below). The budget includes increases in basic education funding and preserves funding for core state government functions and services.
Fiscal Year 2023 Budget
The Governor signed a Fiscal Year 2023 budget on August 3, 2023. The budget allocates $44,974.4 million to the state General Fund.
Fiscal Year 2022 Budget
The Pennsylvania legislature approved, and the Governor signed, a Fiscal Year 2022 budget on July 8, 2022. The enacted budget allocates $42,800 million to the state General Fund. The budget includes increases in education funding at all levels and preserves funding for core state government functions and services.
Fiscal Year 2021 Budget
The Pennsylvania legislature approved, and the Governor signed a final fiscal year budget on November 23, 2020. The enacted budget contains $33.1 billion in state General Fund spending and appropriates $1.3 billion in Coronavirus Aid, Relief and Economic Security Act funding for Commonwealth public safety and health care costs incurred due to the COVID-19 pandemic. The budget level-funds education at all levels and preserves funding for core state government functions and services.
City of Philadelphia
Philadelphia is the largest city in the Commonwealth with an estimated population of 1,603,797 according to the U.S. Census Bureau’s 2020 Decennial Census.
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The Pennsylvania Intergovernmental Cooperation Authority (“PICA”) was created by Commonwealth legislation in 1991 to assist Philadelphia in remedying its fiscal emergencies. PICA is authorized to provide financial assistance to Philadelphia through the issuance of debt, and to make factual findings and recommendations to Philadelphia concerning its budgetary and fiscal affairs. This financial assistance has included grants used by the city for defeasance of certain city general obligation bonds, funding of capital projects and the liquidation of the cumulative general fund balance deficit of Philadelphia as of June 30, 1992, of $224.9 million. Under the PICA act, the City is required to submit to PICA: (i) a five-year financial plan on an annual basis; and (ii) quarterly financial reports. Currently the City is operating under a five-year financial plan that covers fiscal years 2020 through 2024, which was approved by PICA.
Over the years, Philadelphia has expressed a desire to retain the financial oversight and reporting requirements of the PICA act beyond the expiration of the PICA Bonds. Act 36 of 2022 amended the PICA Act to, among other things, (i) extend the term of PICA’s existence until the later of January 2, 2047 or one year after all its liabilities are met or, in the case of PICA Bonds, one year after provision for such payment shall have been made or provided for in the applicable bond indenture; (ii) continue all of the financial oversight and reporting requirements of the PICA act for the life of PICA (regardless of whether PICA Bonds are outstanding); (iii) permit on a limited basis, at the request of Philadelphia, the issuance of PICA Bonds for capital projects of Philadelphia; and (iv) continue the authorization and dedication of the PICA Tax for so long as PICA remains in existence (regardless of whether any PICA Bonds are outstanding).
Neither the taxing power nor the credit of the Commonwealth is pledged to pay debt service on the PICA bonds. There are no PICA bonds outstanding as of June 30, 2023.
Commonwealth Debt
The Constitution permits the Commonwealth to incur the following types of debt: (i) debt to suppress insurrection or rehabilitate areas affected by disaster, (ii) electorate approved debt, (iii) debt for capital projects subject to the constitutional debt limit, and (iv) tax anticipation notes payable in the fiscal year of issuance. All debt, except tax anticipation notes, must be amortized in substantial and regular amounts. Debt service on Commonwealth general obligation debt is paid from appropriations out of the General Fund except for debt issued for highway purposes, which is paid from Motor License Fund appropriations.
Net outstanding general obligation debt totaled $10,206.6 million at June 30, 2023, an increase of $121.9 million over June 30, 2022. Over the 10-year period ending June 30, 2023, total net outstanding general obligation debt decreased at an annual rate of 0.6%. Over the 5-year period ending June 30, 2023, outstanding general obligation debt had decreased at an annual rate of 3.9%.
Certain Commonwealth-created organizations have statutory authorization to issue debt for which Commonwealth appropriations to pay debt service thereon are not required. The debt of these organizations is funded by assets of, or revenues derived from, the various projects financed and is not a statutory or moral obligation of the Commonwealth. However,
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some of these organizations are indirectly dependent upon Commonwealth operating appropriations. In addition, the Commonwealth may choose to take action to financially assist these organizations. These organizations include the Delaware River Joint Toll Bridge Commission, the Delaware River Port Authority, the Pennsylvania Economic Development Financing Authority, the Pennsylvania Higher Education Assistance Agency, the Pennsylvania Higher Educational Facilities Authority, the Pennsylvania Industrial Development Authority, the Pennsylvania Infrastructure Investment Authority, the Pennsylvania Turnpike Commission and the State Public School Building Authority.
Litigation
In 1978, the General Assembly approved a limited waiver of sovereign immunity. Damages for any loss are limited to $250,000 for each person and $1,000,000 for each accident. This cap does not apply to tax appeals. The Supreme Court of Pennsylvania has held that this limitation is constitutional. A number of suits against the Commonwealth remain open. Tort claim payments for the departments and agencies are paid from departmental and agency operating and program appropriations, except for claims against the Department of Transportation, which are paid from an appropriation from the Motor License Fund. The Commonwealth also represents and indemnifies employees who have been sued under Federal civil rights statutes for actions taken in good faith in carrying out their employment responsibilities. There are no caps on damages in civil rights actions. The Commonwealth’s self-insurance program covers damages in these civil cases up to $250,000 per incident. Damages in excess of $250,000 are paid from departmental and agency operating and program appropriations.
VIRGINIA PORTFOLIO
The following is based on information obtained from an Official Statement, dated February 14, 2024, relating to $64,145,000 General Obligation Bonds and $118,080,000 General Obligation Refunding Bonds, as well as an Appendix B to the Official Statement, dated June 27, 2024 and data obtained from the U.S. Bureau of Economic Analysis.
Economic Climate
The 2023 estimated population of the Commonwealth of Virginia (“Virginia” or the “Commonwealth”) was 8,715,698. Among the 50 states, it ranked twelfth in population and has 39,490 square miles of land area.
The Commonwealth is divided into five distinct regions. The Tidewater region is a coastal plain cut into peninsulas by four large tidal rivers. It includes the Eastern Shore and estuaries of the Chesapeake Bay. The Piedmont Plateau region is the largest geographical land of the state, and is characterized by low, rolling hills. The Blue Ridge Mountain region, which lies to the west of the Piedmont Plateau region, is the main eastern mountain range of the Appalachian Mountains. The Appalachian Ridge and Valley region stretches from southwest to northeast along Virginia’s western border and includes the Shenandoah Valley. The Appalachian Plateau region lies in the far southwestern portion of Virginia. The topography of this region is characterized by rivers, streams, and forests. Approximately one-third of all land in Virginia is
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used for farming and other agricultural services. This variety of terrain, the location of the Commonwealth on the Atlantic Seaboard at the southern extremity of the northeast population corridor and its close proximity to the nation’s capital have had a significant influence on the development of the present economic structure of the Commonwealth.
The largest metropolitan area is the Northern Virginia portion of the Washington, D.C. metropolitan area. This is the fastest growing metropolitan area in the Commonwealth. Northern Virginia has long been characterized by the large number of people employed in both civilian and military work with the federal government. It is also one of the nation’s leading high-technology centers for computer software and telecommunications.
Spanning Hampton Roads is the Virginia Beach-Norfolk-Newport News metropolitan area, which has large military instillations and major port facilities. The Richmond metropolitan area is the third largest metropolitan area and is a leading center of diversified manufacturing activity including chemicals, tobacco, printing, paper, metals and machinery. Richmond is also the capital of the Commonwealth and its financial center. The Roanoke metropolitan area is the manufacturing, trade and transportation center for the western part of the Commonwealth.
In 2023, Virginia had per capita personal income of $72,855, ranking twelfth among the states and greater than the national average of $68,531. From 2013 to 2023, Virginia’s compound annual growth rate of per capital income was 4.2%, which was less than the national compound annual growth rate of 4.4%.
As of December 2023, up to 4.5 million residents of the Commonwealth were estimated to be in the civilian labor force, which includes agricultural and non-agricultural employment, the unemployed, the self-employed and residents who commute to jobs in other states. More than 10% of Virginia’s workers are federal employees or active military. From 2019 to 2023, the most significant employment growth has occurred in the Information Services (12.7%), Construction (7.4%) and Professional and Business Activities (6.6) sectors, while the largest declines were in the Natural Resource & Mining (-14.6%) and Leisure and Hospitality Services (-4.1%) sectors.
The Commonwealth is one of 26 states with a right-to-work law and has a record of good labor-management relations. During 2023, Virginia experienced job growth in nine of the eleven metropolitan areas (with one metropolitan area remaining unchanged, and no data being produced for the other). The largest increase of the eleven metropolitan areas occurred in Northern Virginia, up by 25,500 jobs, followed by Richmond, up by 17,400 jobs. As of November 2023, an average of 2.9% of the Commonwealth’s population was unemployed, compared to 3.7% for the nation.
COVID-19 Developments
The Commonwealth incurred significant costs to address the COVID-19 pandemic but received significant federal aid to help cover such costs. In addition to federal disaster relief funds, the Commonwealth received approximately $3.1 billion in funds from the federal Coronavirus Aid, Relief, and Economic Security (“CARES”) Act of 2020 to help cover
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costs related to the pandemic. Of that amount, the Governor allocated approximately $1.3 billion to the cities and counties in Virginia (excluding Fairfax County, which received approximately $200 million in CARES Act funding directly from the federal government based on the large size of the county’s population) and retained approximately $1.8 billion to pay or reimburse costs incurred by the Commonwealth and its related entities to address the pandemic.
The Commonwealth received approximately $4.3 billion in May 2021 from the State and Local Recovery Fund (“SLRF”) established by the federal American Rescue Plan Act of 2021 (“ARPA”), which is in addition to the CARES Act funding described above. Virginia cities and counties received separately approximately $2.3 billion in ARPA-SLRF funding directly from the federal government, and the Commonwealth received approximately $317 million in May 2021 to pass through to smaller cities and towns and received an additional approximately $317 million for the same purpose in May 2022. In total, the Commonwealth and its cities and counties received approximately $7.2 billion in ARPA-SLRF funding. The 2020-2022 biennial budget, as amended, appropriated approximately $3.3 billion of the ARPA-SLRF funds to Fiscal Year 2022 expenditures. The 2022-2024 biennium budget adopted in June 2022 appropriates approximately $900 million in ARPA-SLRF funds to Fiscal Year 2023 expenditures and approximately $100 million in ARPA-SLRF funds to Fiscal Year 2024 expenditures. The ARPA-SLRF-funded expenditures primarily serve the following needs: (1) unemployment assistance; (2) broadband expansion; (3) small business assistance; (4) food assistance; (5) drinking water, wastewater and combined sewer overflow projects; (6) improved mental health and other public health services; (7) public safety; and (8) public education.
Budgetary Process
Virginia has a biennial budget system. The biennial budget is enacted into law in even-numbered years, and amendments to it are enacted in odd-numbered years. For example, the budget for the 2024-2026 biennium was adopted by the 2024 General Assembly and amendments to the 2022-2024 biennial budget were adopted by the General Assembly during its 2023 session. The Governor is required by statute to present a bill detailing his budget (the “Budget Bill”) for the next biennium and a narrative summary of the Budget Bill to the General Assembly by December 20th in the year immediately prior to each even-year session. Under constitutional provisions, the Governor retains the right, in his review of legislative action on the Budget Bill, to suggest alterations to or to veto appropriations made by the General Assembly. After enactment, the Budget Bill becomes law (the “Appropriation Act”).
In the odd-year sessions of the General Assembly, amendments are considered to the Appropriation Act enacted in the previous year. The Governor submits a Budget Bill by December 20th that includes his proposed amendments. The Appropriation Act enacted in the odd-year session is effective upon passage by the General Assembly, whereas the regular biennial Appropriation Act is effective July 1, the beginning of the biennium.
2023 Appropriation Act and 2023 Special Session Amendments
On December 15, 2022, Governor Youngkin announced his amendments to the 2022-2024 biennium budget. The proposed budget amendments proposed additional funding for behavioral health, law enforcement, education, economic development and conservation efforts.
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The Governor’s plan also included $1 billion in additional tax relief on top of nearly $4 billion in relief passed previously.
The General Assembly began the consideration of the Governor’s proposed budget amendments during the 2023 session that convened on January 11, 2023. A scaled-down set of amendments from both the General Assembly and the Governor were adopted in an interim amended budget which was enacted on April 12, 2023. Changes included in the interim amended budget included: $405.9 million for a required deposit to the Revenue Stabilization Fund; $263.1 million to update the cost of Direct Aid to Public K-12 education for enrollment changes and other technical adjustments; $250 million for a deposit to the Virginia Retirement System to reduce unfunded liabilities; $100 million for supplemental funding for existing capital outlay projects; Treasury Loan authorization for up to $43.3 million in support of a high performance data facility associated with the Thomas Jefferson National Accelerator Facility; $15.3 million for the Temporary Assistance for Needy Families Unemployment Parents program; and technical changes to General Fund Resources to reflect legislation passed by the General Assembly and actual year-end balances from Fiscal Year 2022.
On September 6, 2023, the General Assembly reconvened for a special session to take-up additional amendments to Fiscal Year 2024 appropriations. The amendments were adopted and enacted on September 14, 2023. Changes included in the special session amendments, among others, included: $418.3 million to be distributed to school divisions, $152.3 millions to provide state support for support personnel, $75 million in added operating support for higher education institutions, $62.5 million in additional financial aid for higher education students, $644 million in Water Quality Improvement Fund deposits, $200 million of new funding for business-ready site development, $156 million for mental health services, $263 million of Medicaid savings, and a $289.6 million deposit to the Revenue Reserve Fund.
2024 Amendments to the 2023 Special Session Appropriations Act
On December 20, 2023, Governor Youngkin presented amendments to the 2023 Special Session Appropriations Act affecting appropriations for the remainder of the 2022-2024 biennium, primarily Fiscal Year 2024. The amendments to the 2023 Special Session Appropriations Act were considered by the 2024 Session of the General Assembly which convened on January 10, 2024. The General Assembly adjourned on March 9, 2024, having passed the budget with amendments added which was subsequently returned to the Governor for executive review and action. The Governor called the General Assembly back for a Reconvened Session on April 17, 2024, at which time he presented the budget with a number of executive amendments. The General Assembly did not take-up any of these amendments but instead agreed to return for a special session to reconsider the budget on May 13, 2024. Having reconsidered the budget and folding in additional amendments, the General Assembly passed HB 6002 which amends Fiscal Year 2024 appropriations for the 2022-2024 biennium. The Governor signed HB 6002 on May 13, 2024. The amendments made a number of technical adjustments to funding formulas and other required changes in spending items. Overall, the general fund operating spending is $444.8 million lower than the total included in the 2023 Special Session Appropriation Act.
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2024 Appropriations Act
As part of the reconvened session on May 13, 2024, discussed above, the General Assembly passed HB 6001 which provides appropriations for the 2024-2026 biennium beginning on July 1, 2024. The Governor signed HB 6001 on May 13, 2024. Key features of the 2024 Appropriation Act include, among other things, the following: $21.6 billion in total general and state non-general fund biennial investment into K-12, $7.2 billion general fund operating investment for higher education, the largest in the Commonwealth’s history, representing a growth of 20% from the previous biennium, $840 million General Fund and $845 million of other funds to fully fund Medicaid and Children’s Health Insurance, over $800 million in conservation and resiliency investments, $545.2 million for the biennium to provide a 3% increase in public employee salaries, and $1.9 billion in general fund cash and tax-supported debt for projects.
Litigation
The Commonwealth, its officials and employees are named as defendants in legal proceedings which occur in the normal course of governmental operations, some involving claims for substantial amounts. It is not possible at the present time to estimate the ultimate outcome or liability, if any, of the Commonwealth with respect to these lawsuits. However, any ultimate liability resulting from these suits is not expected to have a material adverse effect on the financial condition of the Commonwealth.
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Additional Investment Policies and Practices
The following information about the Portfolios’ investment policies and practices supplements the information set forth in the Prospectus.
General. Municipal securities include municipal bonds as well as short-term (i.e., maturing in under one year to as much as three years) municipal notes, demand notes and tax-exempt commercial paper. Typically, municipal bonds are issued to obtain funds used to construct a wide range of public facilities, such as schools, hospitals, housing, mass transportation, airports, highways and bridges. The funds may also be used for general operating expenses, refunding of outstanding obligations and loans to other public institutions and facilities.
Municipal bonds have two principal classifications: general obligation bonds and revenue or special obligation bonds. General obligation bonds are secured by the issuer’s pledge of its faith, credit and taxing power for the payment of principal and interest. Revenue or special obligation bonds are payable only from the revenues derived from a particular facility or class of facilities or, in some cases, from the proceeds of a special excise tax or other specific revenue source but not from general tax and other unrestricted revenues of the issuer. The term “issuer” means the agency, authority, instrumentality or other political subdivision whose assets and revenues are available for the payment of principal of and interest on the bonds. Certain types of
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private activity bonds are also considered municipal bonds if the interest thereon is exempt from federal income tax.
Private activity bonds are in most cases revenue bonds and do not generally constitute the pledge of the credit or taxing power of the issuer of such bonds. The payment of the principal and interest on such private activity bonds depends solely on the ability of the user of the facilities financed by the bonds to meet its financial obligations and the pledge, if any, of real and personal property so financed as security for such payment.
Each Portfolio may invest a portion of its assets in municipal securities that pay interest at a coupon rate equal to a base rate plus additional interest for a certain period of time if short-term interest rates rise above a predetermined level or “cap.” Although the specific terms of these municipal securities may differ, the amount of any additional interest payment typically is calculated pursuant to a formula based upon an applicable short-term interest rate index multiplied by a designated factor. The additional interest component of the coupon rate of these municipal securities generally expires before the maturity of the underlying instrument. These municipal securities may also contain provisions that provide for conversion at the option of the issuer to constant interest rates in addition to standard call features.
The Portfolios may invest in zero-coupon municipal securities, which are debt obligations that do not entitle the holder to any periodic payments prior to maturity and are issued and traded at a discount from their face amounts. The discount varies depending on the time remaining until maturity, prevailing interest rates, liquidity of the security and perceived credit quality of the issuer. The market prices of zero-coupon municipal securities are generally more volatile than the market prices of securities that pay interest periodically and are likely to respond to changes in interest rates to a greater degree than do securities having similar maturities and credit quality that do pay periodic interest.
Each Portfolio may also invest in municipal securities, the interest rate on which has been divided into two different and variable components, which together result in a fixed interest rate. Typically, the first of the components (the “Auction Component”) pays an interest rate that is reset periodically through an auction process, whereas the second of the components (the “Residual Component”) pays a current residual interest rate based on the difference between the total interest paid by the issuer on the municipal securities and the auction rate paid on the Auction Component. A Portfolio may purchase both Auction and Residual Components.
Because the interest rate paid to holders of Residual Components is generally determined by subtracting the interest rate paid to the holders of Auction Components from a fixed amount, the interest rate paid to Residual Component holders will decrease the Auction Component’s rate increases and increase as the Auction Component’s rate decreases. Moreover, the extent of the increases and decreases in market value of Residual Components may be larger than comparable changes in the market value of an equal principal amount of a fixed-rate municipal security having similar credit quality, redemption provisions and maturity.
Municipal notes in which a Portfolio may invest include demand notes, which are tax-exempt obligations that have stated maturities in excess of one year, but permit the holder to sell back the security (at par) to the issuer within one to seven days’ notice. The payment of
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principal and interest by the issuer of these obligations will ordinarily be guaranteed by letters of credit offered by banks. The interest rate on a demand note may be based upon a known lending rate, such as a bank’s prime rate, and may be adjusted when such rate changes, or the interest rate on a demand note may be a market rate that is adjusted at specified intervals.
Other short-term obligations constituting municipal notes include tax anticipation notes, revenue anticipation notes, bond anticipation notes and tax-exempt commercial paper.
Tax anticipation notes are issued to finance working capital needs of municipalities. Generally, they are issued in anticipation of various seasonal tax revenues, such as ad valorem, income, sales, use and business taxes. Revenue anticipation notes are issued in expectation of receipt of other types of revenues, such as federal revenues available under the Federal Revenue Sharing Programs. Bond anticipation notes are issued to provide interim financing until long-term financing can be arranged. In most such cases, the long-term bonds provide the money for the repayment of the notes.
Tax-exempt commercial paper is a short-term obligation with a stated maturity of 365 days or less (however, issuers typically do not issue such obligations with maturities longer than seven days). Such obligations are issued by state and local municipalities to finance seasonal working capital needs or as short-term financing in anticipation of longer-term financing.
Each Fund Portfolio and Fund II Portfolio (other than the High Income Portfolio) will invest at least 75% of its total assets in municipal securities rated at the time of purchase Baa or higher (including Baa1, Baa2 and Baa3) by Moody’s Investors Service, Inc. (“Moody’s”) or BBB or higher (including BBB+ and BBB-) by S&P Global Ratings (“S&P”) or Fitch Ratings (“Fitch”) or the equivalent by any other NRSRO or, if unrated, determined by the Adviser to be of comparable quality. For additional information on securities ratings, please see Appendix A.
There are, of course, variations in the terms of, and the security underlying, municipal securities, both within a particular rating classification and between such classifications, depending on many factors. The ratings of NRSROs represent their opinions of the quality of the municipal securities rated by them. It should be emphasized that such ratings are general and are not absolute standards of quality. Consequently, municipal securities with the same maturity, coupon and rating may have different yields, while the municipal securities of the same maturity and coupon, but with different ratings, may have the same yield. The Adviser appraises independently the fundamental quality of the securities included in the Portfolios’ portfolios.
Yields on municipal securities are dependent on a variety of factors, including the general conditions of the municipal securities market, the size of a particular offering, the maturity of the obligation and the rating of the issue. An increase in interest rates generally will reduce the market value of portfolio investments, and a decline in interest rates generally will increase the value of portfolio investments. Municipal securities with longer maturities tend to produce higher yields and are generally subject to greater price movements than obligations with shorter maturities. Under normal circumstances the average weighted maturity of the securities in each Portfolio will range between 10 and 30 years. However, no Portfolio has any restrictions
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on the maturity of municipal securities in which it may invest. Since the Portfolios’ objective is to provide high current income, they will emphasize income rather than stability of net asset values (“NAVs”), and the average maturity of the Portfolios will vary depending on anticipated market conditions. The Portfolios will seek to invest in municipal securities of such maturities that, in the judgment of the Adviser, will provide a high level of current income consistent with liquidity requirements and market conditions. The achievement of the Portfolios’ respective investment objectives depends in part on the continuing ability of the issuers of municipal securities in which the Portfolios invest to meet their obligations for the payment of principal and interest when due. Municipal securities historically have not been subject to registration with the Securities and Exchange Commission (“SEC”), although from time to time there have been proposals which would require registration in the future.
After purchase by a Portfolio, a municipal security may cease to be rated, its rating may be reduced below the minimum required for purchase by such Portfolio or it may default. These events do not require sales of such securities by the Portfolio, but the Adviser will consider such event in its determination of whether the Portfolio should continue to hold the security. To the extent that the ratings given by NRSROs may change as a result of changes in such organizations or their rating systems, the Adviser will attempt to use such changed ratings in a manner consistent with a Portfolio’s quality criteria as described in the Prospectus.
A Portfolio’s investments in municipal securities are subject to the risks associated with a lack of liquidity in the municipal bond market. Inventories of municipal securities held by brokers and dealers have decreased in recent years, reducing their ability to make a market in these securities. This reduction in market making capacity has the potential to diminish a Portfolio's ability to buy or sell municipal securities, and increase price volatility and trading costs, particularly during periods of economic or market stress. Consequently, a Portfolio may have to accept a lower price to sell a municipal security, to sell other securities to raise cash, or to forfeit an investment opportunity, any of which could have an adverse effect on the Portfolio’s performance.
Obligations of issuers of municipal securities are subject to the provisions of bankruptcy, insolvency, and other laws affecting the rights and remedies of creditors, such as the Federal Bankruptcy Code. In addition, the obligations of such issuers may become subject to laws enacted in the future by Congress, state legislatures, or referenda extending the time for payment of principal and/or interest, or imposing other constraints upon enforcement of such obligations or upon the ability of municipalities to levy taxes. There is also the possibility that, as a result of litigation or other conditions, the ability of any issuer to pay, when due, the principal or the interest on its municipal bonds may be materially affected.
Proposals have been considered by Congress for the purpose of restricting or eliminating the federal income tax exemption for interest on municipal securities. If such a proposal were enacted, the availability of municipal securities for investment by a Portfolio and the NAV and yield of the Portfolio would be affected. In addition, the Adviser would likely need to reevaluate the Portfolios’ investment objectives and policies.
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Asset-Backed Securities, Mortgage-Related Securities and Structured Securities
Each Portfolio may also invest in (i) asset-backed securities, which are securities issued by special purpose entities whose primary assets consist of, for the purposes of a Portfolio’s investment, a pool of municipal securities, or (ii) partnership and grantor trust-type derivative securities, whose ownership allows the purchaser to receive principal and interest payments on underlying municipal securities. The securities may be in the form of a beneficial interest in a special purpose trust, limited partnership interest, or other debt securities issued by a special purpose corporation. Although the securities may have some form of credit or liquidity enhancement, payments on the securities depend predominately upon the municipal securities held by the issuer. There are many types of these securities, including securities in which the tax-exempt interest rate is determined by an index, a swap agreement, or some other formula, for example, the interest rate payable on the security may adjust either at pre-designated periodic intervals or whenever there is a change in the market rate to which the security’s interest rate is tied. Other features may include the right of the Portfolio to tender the security prior to its stated maturity.
The Portfolios may invest in mortgage-related securities, which are typically securities representing interests in pools of mortgage loans made by lenders such as savings and loan associations, mortgage bankers and commercial banks, and which are assembled for sale to investors (such as the Portfolio) by governmental, government-related or private organizations. Private organizations include commercial banks, savings associations, mortgage companies, investment banking firms, finance companies, special purpose finance entities (called special purpose vehicles or SPVs) and other entities that acquire and package loans for resale as mortgage-related securities. Specifically, these securities may include pass-through mortgage-related securities, collateralized mortgage obligations (“CMOs”), stripped mortgage-backed securities (“SMRSs”), commercial mortgage-backed securities, “to be announced” (“TBA”) mortgage-backed securities, mortgage dollar rolls, collateralized obligations and other securities that directly or indirectly represent a participation in or are secured by and payable from mortgage loans on real property and other assets.
Interests in pools of mortgage-related securities differ from other forms of debt securities, which normally provide for periodic payment of interest in fixed amounts with principal payments at maturity or specified call dates. Instead, these securities provide a monthly payment consisting of both interest and principal payments. In effect, these payments are a “pass-through” of the monthly payments made by the individual borrowers on their residential mortgage loans, net of any fees paid to the issuer or guarantor of such securities. Additional payments are caused by repayments of principal resulting from the sale of the underlying residential property, refinancing or foreclosure, net of fees or costs that may be incurred. Some mortgage-related securities, such as securities issued by the Government National Mortgage Association (“GNMA”), are described as “modified pass-through.” These securities entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of certain fees, regardless of whether or not the mortgagor actually makes the payment.
The average life of pass-through pools varies with the maturities of the underlying mortgage instruments. In addition, a pool’s term may be shortened by unscheduled or early payments of principal and interest on the underlying mortgages. The occurrence of mortgage
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prepayments is affected by factors including the level of interest rates, general economic conditions, the location and age of the mortgage and other social and demographic conditions. As prepayment rates of individual pools vary widely, it is not possible to accurately predict the average life of a particular pool. Yields on pass-through securities are typically quoted by investment dealers and vendors based on the maturity of the underlying instruments and the associated average life assumption. In periods of falling interest rates, the rate of prepayment tends to increase, thereby shortening the actual average life of a pool of mortgage-related securities. Conversely, in periods of rising interest rates the rate of prepayment tends to decrease, thereby lengthening the actual average life of the pool. Actual prepayment experience may cause the yield to differ from the assumed average life yield. Reinvestment of prepayments may occur at higher or lower interest rates than the original investment, thus affecting the yield of the Portfolio. The compounding effect from reinvestment of monthly payments received by the Portfolio will increase the yield to shareholders compared with bonds that pay interest semi-annually.
The principal governmental (i.e., backed by the full faith and credit of the United States Government) guarantor of mortgage-related securities is GNMA. GNMA is a wholly-owned United States Government corporation within the Department of Housing and Urban Development. GNMA is authorized to guarantee, with the full faith and credit of the United States Government, the timely payment of principal and interest on securities issued by institutions approved by GNMA (such as savings and loan institutions, commercial banks and mortgage bankers) and backed by pools of Federal Housing Administration (“FHA”)-insured or U.S. Department of Veterans Affairs (“VA”)-guaranteed mortgages.
Government-related (i.e., not backed by the full faith and credit of the U.S. Government) guarantors include Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”). FNMA and FHLMC are each a government-sponsored corporation or corporate instrumentality of the U.S. Government, respectively (government-sponsored entities or “GSEs”), which were owned entirely by private stockholders until 2008 when they were placed in conservatorship by the U.S. Government in an effort to provide stability in the financial markets and put the GSEs in a sound and solvent condition. After being placed in conservatorship, the GSEs issued senior preferred stock and common stock to the U.S. Treasury in an amount equal to 79.9% of each GSE in return for certain funding and liquidity arrangements. The GSEs continue to operate as going concerns while in conservatorship and each remains liable for all of its obligations associated with its mortgage-backed securities. The U.S. Treasury provided additional funding to the GSEs, but the GSEs have paid dividends to the U.S. Treasury in a cumulative amount that exceeds the payments made to the GSEs by the U.S. Treasury since 2008. The future of the GSEs is unclear as Congress has considered proposals to wind down or restructure the operations of the GSEs. It is uncertain what legislation, if any, may be proposed in the future in Congress or which proposals, if any, might be enacted. The passage of any such proposal has the potential to impact the value of securities issued by a GSE, which could adversely affect the liquidity and value of a Fund’s portfolio.
FNMA purchases residential mortgages from a list of approved seller/servicers which include state and federally-chartered savings and loan associations, mutual savings banks, commercial banks and credit unions and mortgage bankers. Pass-through securities issued by
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FNMA are guaranteed as to timely payment of principal and interest by FNMA. Participation certificates issued by FHLMC, which represent interests in mortgages from FHLMC’s national portfolio, are guaranteed by FHLMC as to the timely payment of interest and ultimate collection of principal.
Commercial banks, savings and loan associations, private mortgage insurance companies, mortgage bankers and other secondary market issuers create pass-through pools of conventional residential mortgage loans. Securities representing interests in pools created by non-governmental private issuers generally offer a higher rate of interest than securities representing interests in pools created by governmental issuers because there are no direct or indirect governmental guarantees of the underlying mortgage payments. However, private issuers sometimes obtain committed loan facilities, lines of credit, letters of credit, surety bonds or other forms of liquidity and credit enhancement to support the timely payment of interest and principal with respect to their securities if the borrowers on the underlying mortgages fail to make their mortgage payments. The ratings of such non-governmental securities are generally dependent upon the ratings of the providers of such liquidity and credit support and would be adversely affected if the rating of such an enhancer were downgraded.
The structuring of the pass-through pool may also provide credit enhancement. Examples of such credit support arising out of the structure of the transaction include the issue of senior and subordinated securities (e.g., the issuance of securities by a SPV in multiple classes or “tranches”, with one or more classes being senior to other subordinated classes as to payment of principal and interest, with the result that defaults on the underlying mortgage loans are borne first by the holders of the subordinated class); creation of “reserve funds” (in which case cash or investments sometimes funded from a portion of the payments on the underlying mortgage loans, are held in reserve against future losses); and “overcollateralization” (in which case the scheduled payments on, or the principal amount of, the underlying mortgage loans exceeds that required to make payment of the securities and pay any servicing or other fees). There can be no guarantee the credit enhancements, if any, will be sufficient to prevent losses in the event of defaults on the underlying mortgage loans.
In addition, mortgage-related securities that are issued by private issuers are not subject to the underwriting requirements for the underlying mortgages that are applicable to those mortgage-related securities that have a government or government-sponsored entity guaranteed. As a result, the mortgage loans underlying private mortgage-related securities may, and frequently do, have less favorable collateral, credit risk or other underwriting characteristics than government or government-sponsored mortgage-related securities and have wider variances in a number of terms, including interest rate, term, size, purposes and borrower characteristics. Privately issued pools more frequently include second mortgages, high loan-to-value mortgages and manufactured housing loans. The coupon rates and maturities of the underlying mortgage loans in a private-label mortgage-related pool may vary to a greater extent than those included in a government guaranteed pool, and the pool may include subprime mortgage loans. Subprime loans refer to loans made to borrowers with weakened credit histories or with a lower capacity to make timely payments on their loans. For these reasons, the loans underlying these securities have had in many cases higher default rates than those loans that meet government underwriting requirements.
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A Portfolio may invest in other forms of mortgage-related securities including CMOs, which are debt obligations of the issuer secured by a pool of mortgage loans pledged as collateral that is legally required to be paid by the issuer, regardless of whether payments are actually made on the underlying mortgages. CMOs are the predominant type of a “pay-through” mortgage-related security. In a CMO, a series of bonds or certificates is issued in multiple classes. Each class of a CMO, often referred to as a “tranche”, is issued at a specific coupon rate and has a stated maturity or final distribution date. Principal prepayments on collateral underlying a CMO may cause one or more tranches of the CMO to be retired substantially earlier than the stated maturities or final distribution dates of the collateral. Although payment of the principal of, and interest on, the underlying collateral securing privately issued CMOs may be guaranteed by GNMA, FNMA or FHLMC, these CMOs represent obligations solely of the private issuer and are not insured or guaranteed by GNMA, FNMA, FHLMC, any other governmental agency or any other person or entity.
ARMS, another type of mortgage-related security, bear interest at a rate determined by reference to a predetermined interest rate or index. ARMS may be secured by fixed-rate mortgages or adjustable-rate mortgages. ARMS secured by fixed-rate mortgages generally have lifetime caps on the coupon rates of the securities. To the extent that general interest rates increase faster than the interest rates on the ARMS, these ARMS will decline in value. The adjustable-rate mortgages that secure ARMS will frequently have caps that limit the maximum amount by which the interest rate or the monthly principal and interest payments on the mortgages may increase. These payment caps can result in negative amortization (i.e., an increase in the balance of the mortgage loan). Furthermore, since many adjustable-rate mortgages only reset on an annual basis, the values of ARMS tend to fluctuate to the extent that changes in prevailing interest rates are not immediately reflected in the interest rates payable on the underlying adjustable-rate mortgages.
A Portfolio may invest in SMRS, which are mortgage-related securities that are usually structured with separate classes of securities collateralized by a pool of mortgages or a pool of mortgage backed bonds or pass-through securities, with each class receiving different proportions of the principal and interest payments from the underlying assets. A common type of SMRS has one class of interest-only securities (IOs) receiving all of the interest payments from the underlying assets and one class of principal-only securities (POs) receiving all of the principal payments from the underlying assets. IOs and POs are extremely sensitive to interest rate changes and are more volatile than mortgage-related securities that are not stripped. IOs tend to decrease in value as interest rates decrease and are extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets, and a rapid rate of principal prepayments may have a material adverse effect on the yield to maturity of the IO class. POs generally increase in value as interest rates decrease. If prepayments of the underlying mortgages are greater than anticipated, the amount of interest earned on the overall pool will decrease due to the decreasing principal balance of the assets. Due to their structure and underlying cash flows, SMRS may be more volatile than mortgage-related securities that are not stripped. Changes in the values of IOs and POs can be substantial and occur quickly, such as occurred in the first half of 1994 when the value of many POs dropped precipitously due to increases in interest rates.
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With respect to residential SMRS, a Portfolio will only invest in such SMRS that are issued by the U.S. Government, its agencies or instrumentalities and supported by the full faith and credit of the United States or by other U.S. Government-sponsored entities. Although SMRS are purchased and sold by institutional investors through several investment banking firms acting as brokers or dealers, the complexity of these instruments and the smaller number of investors in the sector can lead to illiquid markets in the sector.
A Portfolio may also invest in commercial mortgage-backed securities, which are securities that represent an interest in, or are secured by, mortgage loans secured by multifamily or commercial properties, such as industrial and warehouse properties, office buildings, retail space and shopping malls, and cooperative apartments, hotels and motels, nursing homes, hospitals and senior living centers. Commercial mortgage-backed securities have been issued in public and private transactions by a variety of public and private issuers using a variety of structures, some of which were developed in the residential mortgage context, including multi-class structures featuring senior and subordinated classes. Commercial mortgage-backed securities may pay fixed or floating-rates of interest. The commercial mortgage loans that underlie commercial mortgage-related securities have certain distinct risk characteristics. Commercial mortgage loans generally lack standardized terms, which may complicate their structure, tend to have shorter maturities than residential mortgage loans and may not be fully amortizing. Commercial properties themselves tend to be unique and are more difficult to value than single-family residential properties. Commercial mortgage-backed securities are subject to heightened risks due to the significant economic impacts of COVID-19 on commercial real estate. In addition, commercial properties, particularly industrial and warehouse properties, are subject to environmental risks and the burdens and costs of compliance with environmental laws and regulations. Global climate change may also have an adverse effect on property and security values.
Each type of asset-backed security also entails unique risks depending on the type of assets involved and the legal structure used. For example, credit card receivables are generally unsecured obligations of the credit card holder 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 owed on the credit cards, thereby reducing the balance due. There have also been proposals to cap the interest rate that a credit card issuer may charge. In some transactions, the value of the asset-backed security is dependent on the performance of a third party acting as credit enhancer or servicer. Furthermore, in some transactions (such as those involving the securitization of vehicle loans or leases) it may be administratively burdensome to perfect the interest of the security issuer in the underlying collateral and the underlying collateral may become damaged or stolen.
Certain Risks. The value of mortgage-related securities is affected by a number of factors. Unlike traditional debt securities, which have fixed maturity dates, mortgage-related securities may be paid earlier than expected as a result of prepayments of underlying mortgages. Such prepayments generally occur during periods of falling mortgage interest rates. If property owners make unscheduled prepayments of their mortgage loans, these prepayments will result in the early payment of the applicable mortgage-related securities. In that event, the Portfolio may be unable to invest the proceeds from the early payment of the mortgage-related securities in investments that provide as high a yield as the mortgage-related securities. Early payments
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associated with mortgage-related securities cause these securities to experience significantly greater price and yield volatility than is experienced by traditional fixed-income securities. The level of general interest rates, general economic conditions and other social and demographic factors affect the occurrence of mortgage prepayments. During periods of falling interest rates, the rate of mortgage prepayments tends to increase, thereby tending to decrease the life of mortgage-related securities. Conversely, during periods of rising interest rates, a reduction in prepayments may increase the effective life of mortgage-related securities, subjecting them to greater risk of decline in market value in response to rising interest rates. If the life of a mortgage-related security is inaccurately predicted, the Portfolio may not be able to realize the rate of return it expected.
As with other fixed-income securities, there is also the risk of nonpayment of mortgage-related securities, particularly for those securities that are backed by mortgage pools that contain subprime loans. Market factors adversely affecting mortgage loan repayments include a general economic downturn, high unemployment, a general slowdown in the real estate market, a drop in the market prices of real estate, or higher mortgage payments required to be made by holders of adjustable rate mortgages due to scheduled increases or increases due to higher interest rates. To the extent a Portfolio invests in mortgage-related securities whose underlying mortgages include subprime or non-performing loans, the risk of default is generally greater.
Subordinated mortgage-related securities may have additional risks. The subordinated mortgage-related security may serve as credit support for the senior securities purchased by other investors. In addition, the payments of principal and interest on these subordinated securities generally will be made only after payments are made to the holders of securities senior to the subordinated securities. Therefore, if there are defaults on the underlying mortgage loans, the holders of subordinated mortgage-related securities will be less likely to receive payments of principal and interest and will be more likely to suffer a loss.
Commercial mortgage-related securities, like all fixed-income securities, generally decline in value as interest rates rise. Moreover, although generally the value of fixed-income securities increases during periods of falling interest rates, this inverse relationship is not as marked in the case of single-family residential mortgage-related securities, due to the increased likelihood of prepayments during periods of falling interest rates, and may not be as marked in the case of commercial mortgage-related securities. The process used to rate commercial mortgage-related securities may focus on, among other factors, the structure of the security, the quality and adequacy of collateral and insurance, and the creditworthiness of the originators, servicing companies and providers of credit support.
Although the market for mortgage-related securities is becoming increasingly liquid, those issued by certain private organizations may not be readily marketable and there may be a limited market for these securities, especially when there is a perceived weakness in the mortgage and real estate market sectors. In particular, the secondary markets for CMOs, IOs and POs may be more volatile and less liquid than those for other mortgage-related securities, thereby potentially limiting the Portfolio’s ability to buy or sell those securities at any particular time. Without an active trading market, mortgage-related securities held in the Portfolio’s portfolio may be particularly difficult to value because of the complexities involved in the value
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of the underlying mortgages. In addition, the NRSROs may have difficulties in rating commercial mortgage-related securities through different economic cycles and in monitoring such ratings on a longer-term basis.
As with fixed-income securities generally, the value of mortgage-related securities can also be adversely affected by increases in general interest rates relative to the yield provided by such securities. Such an adverse effect is especially possible with fixed-rate mortgage securities. If the yield available on other investments rises above the yield of the fixed-rate mortgage securities as a result of general increases in interest rate levels, the value of the mortgage-related securities will decline.
GSE Risk-Sharing Bonds. Another type of mortgage-related security, known as GSE Risk-Sharing Bonds or Credit Risk Transfer securities (“CRTs”), transfers a portion of the risk of borrower defaults from the issuing GSE to investors through the issuance of a bond whose return of principal is linked to the performance of a selected pool of mortgages. CRTs are issued by GSEs (and sometimes banks or mortgage insurers) and structured without any government or GSE guarantee in respect of borrower defaults or underlying collateral. Typically, CRTs are issued at par and have stated final maturities. CRTs are structured so that: (i) interest is paid directly by the issuing GSE and (ii) principal is paid by the issuing GSE in accordance with the principal payments and default performance of a certain pool of residential mortgage loans acquired by the GSE.
The risks associated with an investment in CRTs differ from the risks associated with an investment in mortgage-backed securities issued by GSEs because, in CRTs, some or all of the credit risk associated with the underlying mortgage loans is transferred to the end-investor. As a result, in the event that a GSE fails to pay principal or interest on a CRT or goes through bankruptcy, insolvency or similar proceeding, holders of such CRT have no direct recourse to the underlying mortgage loans.
Derivatives
A Portfolio may, but is not required to, use derivatives for hedging or other risk management purposes or as part of its investment strategies. Derivatives are financial contracts whose value depends on, or is derived from, the value of an underlying asset, reference rate or index. These assets, rates, and indices may include bonds, stocks, mortgages, commodities, interest rates, currency exchange rates, bond indices and stock indices.
There are four principal types of derivatives – options, futures contracts, forwards and swaps. These principal types of derivative instruments, as well as the ways they may be used by a Portfolio, are described below. Derivatives include listed and cleared transactions where the Portfolio’s derivative trade counterparty is an exchange or clearinghouse, and non-cleared bilateral “over-the-counter” (“OTC”) transactions that are privately negotiated and where the Portfolio’s derivative trade counterparty is a financial institution. Exchange-traded or cleared derivatives transactions tend to be subject to less counterparty credit risk than those that are bilateral and privately negotiated. A Portfolio may use derivatives to earn income and enhance returns, to hedge or to adjust the risk profile of a portfolio, and either to replace more traditional direct investments or to obtain exposure to otherwise inaccessible markets.
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Forward Contracts. A forward contract, which may be standardized and exchange-traded or customized and privately negotiated, is an agreement for one party to buy, and the other party to sell, a specific quantity of an underlying security, currency, commodity or other asset for an agreed-upon price at a future date. A forward contract generally is settled by physical delivery of the security, commodity or other tangible asset underlying the forward contract to an agreed upon location at a future date (rather than settled by cash) or is rolled forward into a new forward contract. Non-deliverable forwards (“NDFs”) specify a cash payment upon maturity.
Futures Contracts and Options on Futures Contracts. A futures contract is an agreement that obligates the buyer to buy and the seller to sell a specified quantity of an underlying asset (or settle for cash the value of a contract based on an underlying asset, rate or index) at a specific price on the contract maturity date. Options on futures contracts are options that call for the delivery of futures contracts upon exercise. Futures contracts are standardized, exchange-traded instruments and are fungible (i.e., considered to be perfect substitutes for each other). This fungibility allows futures contracts to be readily offset or canceled through the acquisition of equal but opposite positions, which is the primary method by which futures contracts are liquidated. A cash-settled futures contract does not require physical delivery of the underlying asset, but instead is settled for cash equal to the difference between the values of the contract on the date it is entered into and its maturity date.
Options. An option, which may be standardized and exchange-traded, or customized and privately negotiated, is an agreement that, for a premium payment or fee, gives the option holder (the buyer) the right but not the obligation to buy (a “call”) or sell (a “put”) the underlying asset (or settle for cash an amount based on an underlying asset, rate or index) at a specified price (the exercise price) during a period of time or on a specified date. Likewise, when an option is exercised the writer of the option is obligated to sell (in the case of a call option) or to purchase (in the case of a put option) the underlying asset (or settle for cash an amount based on an underlying asset, rate or index).
Swaps. A swap is an agreement that obligates two parties to exchange a series of cash flows at specified intervals (payment dates) based upon or calculated by reference to changes in specified prices, rates (e.g., interest rates in the case of interest rate swaps or currency exchange rates in the case of currency swaps), or index for a specified amount of an underlying asset (the “notional” principal amount). Most swaps are entered into on a net basis (i.e., the two payment streams are netted out, with a Portfolio receiving or paying, as the case may be, only the net amount of the two payments). Generally, the notional principal amount is used solely to calculate the payment streams but is not exchanged. Pursuant to Commodity Futures Trading Commission (“CFTC”) regulations, certain standardized swaps, including certain interest rate swaps and credit default swaps, are subject to mandatory central clearing and are required to be executed through a regulated swap execution facility. Cleared swaps are transacted through futures commission merchants (“FCMs”) that are members of central clearinghouses with the clearinghouse serving as central counterparty, similar to transactions in futures contracts. Portfolios post initial and variation margin to support their obligations under cleared swaps by making payments to their clearing member FCMs. Central clearing is intended to reduce counterparty credit risks and increase liquidity, but central clearing does not make swap transactions risk free. The SEC may adopt similar clearing and execution requirements in
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respect of certain security-based swaps under its jurisdiction. Privately negotiated swap agreements are two-party contracts entered into primarily by institutional investors and are not cleared through a third party, nor are these required to be executed on a regulated swap execution facility.
Municipal Market Data Rate Locks. The Portfolios may purchase and sell Municipal Market Data Rate Locks (“MMD Rate Locks”). An MMD Rate Lock permits a Portfolio to lock in a specified municipal interest rate for a portion of its portfolio to preserve a return on a particular investment or a portion of its portfolio as a duration management technique or to protect against any increase in the price of securities to be purchased at a later date. A Portfolio may use these transactions as a hedge or for duration or risk management although it is permitted to enter into them to enhance income or gain. An MMD Rate Lock is a contract between a Portfolio and an MMD Rate Lock provider pursuant to which the parties agree to make payments to each other on a notional amount, contingent upon whether the Municipal Market Data AAA General Obligation Scale is above or below a specified level on the expiration date of the contract. For example, if a Portfolio buys an MMD Rate Lock and the Municipal Market Data AAA General Obligation Scale is below the specified level on the expiration date, the counterparty to the contract will make a payment to the Portfolio equal to the specified level minus the actual level, multiplied by the notional amount of the contract. If the Municipal Market Data AAA General Obligation Scale is above the specified level on the expiration date, the Portfolio will make a payment to the counterparty equal to the actual level minus the specified level, multiplied by the notional amount of the contract. In entering into MMD Rate Locks, there is a risk that municipal yields will move in the direction opposite of the direction anticipated by a Portfolio.
Risks of Derivatives and Other Regulatory Issues. Investment techniques employing such derivatives involve risks different from, and, in certain cases, greater than, the risks presented by more traditional investments. Following is a general discussion of important risk factors and issues concerning the use of derivatives.
· | Market Risk. This is the general risk attendant to all investments that the value of a particular investment will change in a way detrimental to a Portfolio’s interest. |
· | Management Risk. Derivative products are highly specialized instruments that require investment techniques and risk analyses different from those associated with stocks and bonds. The use of a derivative requires an understanding not only of the underlying instrument but also of the derivative itself, without the benefit of observing the performance of the derivative under all possible market conditions. In particular, the use and complexity of derivatives require the maintenance of adequate controls to monitor the transactions entered into, the ability to assess the risk that a derivative adds to a Portfolio’s investment portfolio, and the ability to forecast price, interest rate or currency exchange rate movements correctly. |
· | Credit Risk. This is the risk that a loss may be sustained by a Portfolio as a result of the failure of another party to a derivative (usually referred to as a |
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“counterparty”) to comply with the terms of the derivative contract. The credit risk for derivatives traded on an exchange or through a clearinghouse is generally less than for uncleared OTC derivatives, since the performance of the exchange or clearinghouse, which is the issuer or counterparty to each derivative, is supported by all of the members of such exchange or clearinghouse. The performance of an exchange or clearinghouse is further supported by a daily payment system (i.e., margin requirements) operated by the exchange or clearinghouse in order to reduce overall credit risk. There is no similar intermediary support for uncleared OTC derivatives. Therefore, the Portfolio will effect transactions in uncleared OTC derivatives only with investment dealers and other financial institutions (such as commercial banks) deemed creditworthy by the Adviser and the Adviser has adopted procedures for monitoring the creditworthiness of such entities.
· | Counterparty Risk. The value of an OTC derivative will depend on the ability and willingness of a Portfolio’s counterparty to perform its obligations under the transaction. If the counterparty defaults, a Portfolio will have contractual remedies but may choose not to enforce them to avoid the cost and unpredictability of legal proceedings. In addition, if a counterparty fails to meet its contractual obligations, a Portfolio could miss investment opportunities or otherwise be required to retain investments it would prefer to sell, resulting in losses for the Portfolio. Participants in OTC derivatives markets generally are not subject to the same level of credit evaluation and regulatory oversight as are exchanges or clearinghouses. As a result, OTC derivatives generally expose a Portfolio to greater counterparty risk than derivatives traded on an exchange or through a clearinghouse. |
Recent regulations affecting derivatives transactions require certain standardized derivatives, including many types of swaps, to be subject to mandatory central clearing. Under these requirements, a central clearing organization is substituted as the counterparty to each side of the derivatives transaction. Each party to derivatives transactions is required to maintain its positions with a clearing organization through one or more clearing brokers. Central clearing is intended to reduce, but not eliminate, counterparty risk. A Portfolio is subject to the risk that its clearing member or clearing organization will itself be unable to perform its obligations. A Portfolio may also face the indirect risk of the failure of another clearing member customer to meet its obligations to the clearing member, causing a default by the clearing member on its obligations to the clearinghouse.
· | Illiquid Investments Risk. Illiquid investments risk exists when a particular instrument is difficult to purchase, sell or otherwise liquidate. If a derivative transaction is particularly large or if the relevant market is illiquid (as is the case with many privately negotiated derivatives), it may not be possible to initiate a transaction or liquidate a position at an advantageous price. |
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· | Leverage Risk. Since many derivatives have a leverage component, adverse changes in the value or level of the underlying asset, rate or index can result in a loss substantially greater than the amount invested in the derivative itself. In the case of swaps, the risk of loss generally is related to a notional principal amount, even if the parties have not made any initial investment. Certain derivatives have the potential for unlimited loss, regardless of the size of the initial investment. |
· | Regulatory Risk. Various U.S. Government entities, including the CFTC and the SEC, are in the process of adopting and implementing additional regulations governing derivatives markets permitted by, among other things, the Dodd-Frank Act, including clearing as discussed above, margin, reporting and registration requirements. In addition, the SEC has adopted Rule 18f-4 under the 1940 Act, which governs the use of derivatives and certain other forms of leverage by registered investment companies. Rule 18f-4 requires certain funds, among other things, to adopt a comprehensive derivatives risk management program, appoint a derivatives risk manager and comply with a limit on fund leverage risk based on value-at-risk, or “VaR.” Funds that use derivatives in a limited amount are not subject to the full requirements of Rule 18f-4. In addition, Congress, various exchanges and regulatory and self-regulatory authorities have undertaken reviews of futures, options and swaps markets in light of market volatility. Among the actions that have been taken or proposed to be taken are new limits and reporting requirements for speculative positions, new or more stringent daily price fluctuation limits, and increased margin requirements for various types of futures. These regulations and actions may adversely affect a Portfolio’s ability to execute its investment strategy. |
The CFTC has also issued rules requiring certain OTC derivatives transactions that fall within its jurisdiction to be executed through a regulated securities, futures or swap exchange or execution facility. Such requirements may make it more difficult or costly for a Portfolio to enter into highly tailored or customized transactions. They may also render certain strategies in which a Portfolio may otherwise engage impossible or so costly that they will not be economical to implement. If a Portfolio decides to become a direct member of one or more swap exchange or execution facilities, it will be subject to all of the rules of the exchange or execution facility.
European regulation of the derivatives market is also relevant to the extent a Portfolio engages in derivatives transactions with a counterparty that is subject to the European Market Infrastructure Regulation (“EMIR”). EMIR introduced uniform requirements in respect of OTC derivative contracts by requiring certain “eligible” OTC derivatives contracts to be submitted for clearing to regulated central clearing counterparties and by mandating the reporting of certain details of OTC derivatives contracts to trade repositories. In addition, EMIR imposes risk mitigation requirements, including requiring appropriate procedures and arrangements to measure, monitor and mitigate
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operational and counterparty credit risk in respect of OTC derivatives contracts which are not subject to mandatory clearing. These risk mitigation requirements include the exchange, and potentially the segregation, of collateral by the parties, including by a Portfolio. While many of the obligations under EMIR have come into force, a number of other requirements have not yet come into force or are subject to phase-in periods, and certain key issues have not been resolved. It is therefore not fully clear how the OTC derivatives market will ultimately adapt to the evolving European regulatory regime for OTC derivatives.
· | Other Risks. Other risks in using derivatives include the risk of mispricing or improper valuation of derivatives and the inability of derivatives to correlate perfectly with underlying assets, rates and indices. Many derivatives, in particular privately negotiated derivatives, are complex and often valued subjectively. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a Portfolio. Derivatives do not always perfectly or even highly correlate with or track the value of the assets, rates or indices they are designed to closely track. Consequently, a Portfolio’s use of derivatives may not always be an effective means of, and sometimes could be counterproductive to, furthering the Portfolio’s investment objective. |
Other. A Portfolio may purchase and sell derivative instruments only to the extent that such activities are consistent with the requirements of the Commodity Exchange Act (“CEA”) and the rules adopted by the CFTC thereunder. Under CFTC rules, a registered investment company that conducts more than a certain amount of trading in futures contracts, commodity options, certain swaps and other commodity interests is a commodity pool and its adviser must register as a commodity pool operator (“CPO”). Under such rules, registered investment companies that are commodity pools are subject to additional recordkeeping, reporting and disclosure requirements. The Adviser, with respect to the Portfolios, has claimed an exclusion from the definition of CPO under CFTC Rule 4.5 under the CEA based on the extent of the Portfolios’ derivatives use and is not currently subject to these recordkeeping, reporting and disclosure requirements under the CEA.
Use of Options, Futures Contracts, Forwards and Swaps by the Portfolios
— Forward Currency Exchange Contracts. A forward currency exchange contract is an obligation by one party to buy, and the other party to sell, a specific amount of a currency for an agreed-upon price at a future date. A forward currency exchange contract may result in the delivery of the underlying asset upon maturity of the contract in return for the agreed-upon payment. NDFs specify a cash payment upon maturity. NDFs are normally used when the market for physical settlement of the currency is underdeveloped, heavily regulated or highly taxed.
The cost of engaging in forward currency exchange contracts varies with such factors as the currencies involved, the length of the contract period and the market conditions
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then prevailing. Since transactions in foreign currencies are usually conducted on a principal basis, no fees or commissions are involved.
— Options on Securities. In an effort, among other things, to increase current income and to reduce fluctuations in NAV, the Portfolios may write covered put and call options and purchase put and call options on securities, including municipal securities and U.S. Government securities. The Portfolios may also enter into options on the yield “spread” or yield differential between two securities. In addition, the Portfolios may write covered straddles. There are no specific limitations on the writing and purchasing of options by the Portfolios.
A put option gives the purchaser of such option, upon payment of a premium, the right to deliver a specified amount of a security to the writer of the option on or before a fixed date at a predetermined price. A call option gives the purchaser of the option, upon payment of a premium, the right to call upon the writer to deliver a specified amount of a security on or before a fixed date at a predetermined price. In purchasing a call option, a Portfolio would be in a position to realize a gain if, during the option period, the price of the underlying security increased by an amount in excess of the premium paid. It would realize a loss if the price of the underlying security declined or remained the same or did not increase during the period by more than the amount of the premium. In purchasing a put option, the Portfolio would be in a position to realize a gain if, during the option period, the price of the underlying security declined by an amount in excess of the premium paid. It would realize a loss if the price of the underlying security increased or remained the same or did not decrease during that period by more than the amount of the premium. If a put or call option purchased by a Portfolio were permitted to expire without being sold or exercised, its premium would be lost by the Portfolio.
A Portfolio may purchase call options to hedge against an increase in the price of securities that the Portfolio anticipates purchasing in the future. If such increase occurs, the call option will permit the Portfolio to purchase the securities at the exercise price, or to close out the options at a profit. The premium paid for the call option plus any transaction costs will reduce the benefit, if any, realized by the Portfolio upon exercise of the option, and, unless the price of the underlying security rises sufficiently, the option may expire worthless to the Portfolio and the Portfolio will suffer a loss on the transaction to the extent of the premium paid.
A Portfolio may purchase put options to hedge against a decline in the value of portfolio securities. If such decline occurs, the put options will permit the Portfolio to sell the securities at the exercise price or to close out the options at a profit. By using put options in this way, the Portfolio will reduce any profit it might otherwise have realized on the underlying security by the amount of the premium paid for the put option and by transaction costs.
A Portfolio may write a put or call option in return for a premium, which is retained by the Portfolio whether or not the option is exercised. The premium paid by the purchaser of an option will reflect, among other things, the relationship of the exercise price to the market price and volatility of the underlying security, the remaining term of the option, supply and demand and interest rates. A Portfolio may write covered options or uncovered options. A call option written by a Portfolio is “covered” if the Portfolio owns the underlying security covered by the call or has an absolute and immediate right to acquire that security without additional cash consideration upon conversion or exchange of other securities held in its
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portfolio. A call option is also covered if the Portfolio holds a call on the same security and in the same principal amount as the call written where the exercise price of the call held is equal to or less than the exercise price of the call written. A put option written by a Portfolio is “covered” if the Portfolio holds a put on the same security and in the same principal amount as the put written where the exercise price of the put held is equal to or greater than the exercise price of the put written. Uncovered options or “naked options” are riskier than covered options. For example, if a Portfolio wrote a naked call option and the price of the underlying security increased, the Portfolio would have to purchase the underlying security for delivery to the call buyer and sustain a loss, which could be substantial, equal to the difference between the option price and the market price of a security.
In contrast to other types of options, options on the yield “spread” or yield differential between two securities are based on the difference between the yields of designated securities. A Portfolio may also, as an example, write combinations of put and call options on the same security, known as “straddles,” with the same exercise and expiration date. By writing a straddle, the Portfolio undertakes a simultaneous obligation to sell and purchase the same security in the event that one of the options is exercised. If the price of the security subsequently rises above the exercise price, the call will likely be exercised and the Portfolio will be required to sell the underlying security at or below market price. This loss may be offset, however, in whole or in part, by the premiums received on the writing of the two options. Conversely, if the price of the security declines by a sufficient amount, the put will likely be exercised. The writing of straddles will likely be effective, therefore, only where the price of the security remains stable and neither the call nor the put is exercised. In those instances where one of the options is exercised, the loss on the purchase or sale of the underlying security may exceed the amount of the premiums received.
The Portfolios may write call options for cross-hedging purposes. A call option is for cross-hedging purposes if a Portfolio does not own the underlying security, and is designed to provide a hedge against a decline in value in another security which the Portfolio owns or has the right to acquire. A Portfolio would write a call option for cross-hedging purposes, instead of writing a covered call option, when the premium to be received from the cross-hedge transaction would exceed that which would be received from writing a covered call option, while at the same time achieving the desired hedge.
By writing a call option, the Portfolio limits its opportunity to profit from any increase in the market value of the underlying security above the exercise price of the option. By writing a put option, the Portfolio assumes the risk that it may be required to purchase the underlying security for an exercise price above its then current market value, resulting in a capital loss unless the security subsequently appreciates in value. Where options are written for hedging purposes, such transactions constitute only a partial hedge against declines in the value of portfolio securities or against increases in the value of securities to be acquired, up to the amount of the premium. The Portfolio may purchase put options to hedge against a decline in the value of portfolio securities. If such decline occurs, the put options will permit the Portfolio to sell the securities at the exercise price or to close out the options at a profit. By using put options in this way, the Portfolio will reduce any profit it might otherwise have realized on the underlying security by the amount of the premium paid for the put option and by transaction costs.
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A Portfolio may purchase or write options on securities of the types in which they are permitted to invest in privately-negotiated (i.e., OTC) transactions. Options purchased or written in negotiated transactions may be illiquid and it may not be possible for the Portfolios to effect a closing transaction at a time when the Adviser believes it would be advantageous to do so.
— Options on Securities Indices and Municipal and U.S. Government Securities Indices. An option on a securities index is similar to an option on a security except that, rather than taking or making delivery of a security at a specified price, an option on a securities index gives the holder the right to receive, upon exercise of the option, an amount of cash if the closing level of the chosen index is greater than (in the case of a call) or less than (in the case of a put) the exercise price of the option.
A Portfolio may write (sell) call and put options and purchase call and put options on securities indices. If a Portfolio purchases put options on securities indices to hedge its investments against a decline in the value of portfolio securities, it will seek to offset a decline in the value of securities it owns through appreciation of the put option. If the value of the Portfolio’s investments does not decline as anticipated, or if the value of the option does not increase, the Portfolio’s loss will be limited to the premium paid for the option. The success of this strategy will largely depend on the accuracy of the correlation between the changes in value of the index and the changes in value of the Portfolio’s security holdings.
A Portfolio may also write put or call options on securities indices to, among other things, earn income. If the value of the chosen index declines below the exercise price of the put option, the Portfolio has the risk of loss of the amount of the difference between the exercise price and the closing level of the chosen index, which it would be required to pay to the buyer of the put option and which may not be offset by the premium it received upon sale of the put option. Similarly, if the value of the index is higher than the exercise price of the call option, the Portfolio has the risk of loss of the amount of the difference between the exercise price and the closing level of the chosen index, which may not be offset by the premium it received upon sale of the call option. If the value of the securities index is significantly below or above the exercise price of the written option, the Portfolio could experience a substantial loss.
The purchase of call options on securities indices may be used by a Portfolio to attempt to reduce the risk of missing a broad market advance, or an advance in an industry or market segment, at a time when the Portfolio holds uninvested cash or short-term debt securities awaiting investment. When purchasing call options for this purpose, the Portfolio will also bear the risk of losing all or a portion of the premium paid if the value of the index does not rise. The purchase of call options on stock indices when the Portfolio is substantially fully invested is a form of leverage, up to the amount of the premium and related transaction costs, and involves risks of loss and of increased volatility similar to those involved in purchasing call options on securities the Portfolio owns.
— Futures Contracts and Options on Futures Contracts. Futures contracts that a Portfolio may buy and sell may include futures contracts on fixed-income or other securities, and contracts based on interest rates or financial indices, including any index of U.S. Government securities. A Portfolio may, for example, purchase or sell futures contracts and
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options thereon to hedge against changes in interest rates or securities (through index futures or options).
Interest rate futures contracts are purchased or sold for hedging purposes to attempt to protect against the effects of interest rate changes on a Portfolio’s current or intended investments in fixed-income securities. For example, if a Portfolio owned long-term bonds and interest rates were expected to increase, that Portfolio might sell interest rate futures contracts. Such a sale would have much the same effect as selling some of the long-term bonds in that Portfolio’s portfolio. However, since the futures market is generally more liquid than the cash market, the use of interest rate futures contracts as a hedging technique allows a Portfolio to hedge its interest rate risk without having to sell its portfolio securities. If interest rates were to increase, the value of the debt securities in the portfolio would decline, but the value of that Portfolio’s interest rate futures contracts would be expected to increase at approximately the same rate, thereby keeping the NAV of that Portfolio from declining as much as it otherwise would have. On the other hand, if interest rates were expected to decline, interest rate futures contracts could be purchased to hedge in anticipation of subsequent purchases of long-term bonds at higher prices. Because the fluctuations in the value of the interest rate futures contracts should be similar to those of long-term bonds, a Portfolio could protect itself against the effects of the anticipated rise in the value of long-term bonds without actually buying them until the necessary cash becomes available or the market has stabilized. At that time, the interest rate futures contracts could be liquidated and that Portfolio’s cash reserves could then be used to buy long-term bonds on the cash market.
Purchases or sales of stock or bond index futures contracts are used for hedging or risk management purposes to attempt to protect a Portfolio’s current or intended investments from broad fluctuations in stock or bond prices. For example, a Portfolio may sell stock or bond index futures contracts in anticipation of or during a market decline to attempt to offset the decrease in market value of the Portfolio’s portfolio securities that might otherwise result. If such decline occurs, the loss in value of portfolio securities may be offset, in whole or in part, by gains on the futures position. When a Portfolio is not fully invested in the securities market and anticipates a significant market advance, it may purchase stock or bond index futures contracts in order to gain rapid market exposure that may, in whole or in part, offset increases in the cost of securities that the Portfolio intends to purchase. As such purchases are made, the corresponding positions in stock or bond index futures contracts may be closed out.
Options on futures contracts are options that call for the delivery of futures contracts upon exercise. Options on futures contracts written or purchased by a Portfolio will be traded on U.S. exchanges and, with respect to the Fund Portfolios and Fund II Portfolios, will be used only for hedging purposes.
The writing of a call option on a futures contract constitutes a partial hedge against declining prices of the securities in a Portfolio’s portfolio. If the futures price at expiration of the option is below the exercise price, a Portfolio will retain the full amount of the option premium, which provides a partial hedge against any decline that may have occurred in the Portfolio’s portfolio holdings. The writing of a put option on a futures contract constitutes a partial hedge against increasing prices of the securities or other instruments required to be delivered under the terms of the futures contract. If the futures price at expiration of the put
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option is higher than the exercise price, a Portfolio will retain the full amount of the option premium, which provides a partial hedge against any increase in the price of securities which the Portfolio intends to purchase. If a put or call option a Portfolio has written is exercised, the Portfolio will incur a loss which will be reduced by the amount of the premium it receives. Depending on the degree of correlation between changes in the value of its portfolio securities and changes in the value of its options on futures positions, a Portfolio’s losses from exercised options on futures may to some extent be reduced or increased by changes in the value of portfolio securities.
A Portfolio may purchase options on futures contracts for hedging purposes instead of purchasing or selling the underlying futures contracts. For example, where a decrease in the value of portfolio securities is anticipated as a result of a projected market-wide decline or changes in interest rates, a Portfolio could, in lieu of selling futures contracts, purchase put options thereon. In the event that such a decrease were to occur, it may be offset, in whole or in part, by a profit on the option. If the anticipated market decline were not to occur, the Portfolios would suffer a loss equal to the price of the put. Where it is projected that the value of securities to be acquired by a Portfolio will increase prior to acquisition due to a market advance or changes in interest, a Portfolio could purchase call options on futures contracts, rather than purchasing the underlying futures contracts. If the market advances, the increased cost of securities to be purchased may be offset by a profit on the call. However, if the market declines, the Portfolio will suffer a loss equal to the price of the call, but the securities which the Portfolio intends to purchase may be less expensive.
— Credit Default Swap Agreements. The “buyer” in a credit default swap contract is obligated to pay the “seller” a periodic stream of payments over the term of the contract in return for a contingent payment upon the occurrence of a credit event with respect to an underlying reference obligation. Generally, a credit event means bankruptcy, failure to pay, obligation acceleration or restructuring. A Portfolio may be either the buyer or the seller in the transaction. As a seller, a Portfolio receives a fixed rate of income throughout the term of the contract, which typically is between one month and ten years, provided that no credit event occurs. If a credit event occurs, the Portfolio, as seller, typically must pay the contingent payment to the buyer. The contingent payment will be either (i) the “face amount” of the reference obligation in which case the Portfolio will receive the reference obligation in return, or (ii) an amount equal to the difference between the face amount and the current market value of the obligation. As a buyer, if a credit event occurs, the Portfolio would be the receiver of such contingent payments, either delivering the reference obligation in exchange for the full notional (face) value of a reference obligation that may have little or no value, or receiving a payment equal to the difference between the face amount and the current market value of the obligation.
The value of the reference obligation received by the Portfolio as a seller if a credit event occurs, coupled with the periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the Portfolio. If the reference obligation received by a Portfolio is a defaulted security, physical delivery of the security will cause a Portfolio to hold a defaulted security.
If a Portfolio is a buyer and no credit event occurs, the Portfolio may lose the periodic stream of payments over the term of the contract. However, if a credit event occurs, the
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buyer typically receives full notional value for a reference obligation that may have little or no value.
Credit default swaps may involve greater risks than if a Portfolio had invested in the reference obligation directly. Credit default swaps are subject to general market risk and credit risk, and may be illiquid.
— Swaps: Interest Rate Transactions. A Portfolio may enter into interest rate swap, swaption, cap or floor transactions, which may include preserving a return or spread on a particular investment or portion of its portfolio or protecting against an increase in the price of securities a Portfolio anticipates purchasing at a later date. Unless there is a counterparty default, the risk of loss to a Portfolio from interest rate transactions is limited to the net amount of interest payments that the Portfolio is contractually obligated to make. If the counterparty to an interest rate transaction defaults, the Portfolio may lose the net amount of interest payments it is contractually entitled to receive.
Interest rate swaps involve the exchange by a Portfolio with another party of payments calculated by reference to specified interest rates (e.g., an exchange of floating-rate payments for fixed-rate payments) computed based on a contractually-based principal (or “notional”) amount.
An option on a swap agreement, also called a “swaption,” is an option that gives the buyer the right, but not the obligation, to enter into a swap on a future date in exchange for paying a market-based “premium”. A receiver swaption gives the owner the right to receive the total return of a specified asset, reference rate, or index. A payer swaption gives the owner the right to pay the total return of a specified asset, reference rate, or index. Swaptions also include options that allow an existing swap to be terminated or extended by one of the counterparties.
Interest rate caps and floors are similar to options in that the purchase of an interest rate cap or floor entitles the purchaser, to the extent that a specified index exceeds (in the case of a cap) or falls below (in the case of a floor) a predetermined interest rate, to receive payments of interest on a notional amount from the party selling the interest rate cap or floor. Caps and floors are less liquid than swaps. These transactions do not involve the delivery of securities or other underlying assets or principal. It may be more difficult for a Portfolio to trade or close out interest rate caps and floors in comparison to other types of swaps.
These transactions do not involve the delivery of securities or other underlying assets or principal. A Portfolio will enter into bilateral swap agreements, including interest rate swap, swaption, cap or floor transactions but excluding currency swaps, which are subject to separate counterparty requirements as addressed above, only with counterparties who have credit ratings of at least A- (or the equivalent) from any one NRSRO or counterparties with guarantors with debt securities having such a rating.
— Inflation (CPI) Swaps. Inflation swap agreements are contracts in which one party agrees to pay the cumulative percentage increase in a price index (the Consumer Price Index with respect to CPI swaps) over the term of the swap (with some lag on the inflation index), and the other pays a compounded fixed rate. Inflation swap agreements may be used to
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protect the NAV of a Portfolio against an unexpected change in the rate of inflation measured by an inflation index since the value of these agreements is expected to increase if inflation increases. A Portfolio will enter into inflation swaps on a net basis. The net amount of the excess, if any, of the Portfolio’s obligations over its entitlements with respect to each inflation swap will be accrued on a daily basis, and an amount of cash or liquid instruments having an aggregate NAV at least equal to the accrued excess will be segregated by the Portfolio. The values of inflation swap agreements are expected to change in response to changes in real interest rates. Real interest rates are tied to the relationship between nominal interest rates and the rate of inflation. If nominal interest rates increase at a faster rate than inflation, real interest rates may rise, leading to a decrease in value of an inflation swap agreement. Additionally, payments received by a Portfolio from inflation swap agreements will result in taxable income, either as ordinary income or capital gains, rather than tax-exempt income, which will increase the amount of taxable distributions received by shareholders.
— Total Return Swaps. The Portfolios may enter into total return swaps in order to take a “long” or “short” position with respect to an underlying referenced asset. The Portfolios are subject to market price volatility of the underlying referenced asset. A total return swap involves commitments to pay interest in exchange for a market linked return based on a notional amount. To the extent that the total return of the security, group of securities or index underlying the transaction exceeds or falls short of the offsetting interest obligation, the Portfolios will receive a payment from or make a payment to the counterparty. Total return swaps may reflect a leveraged investment and incorporate borrowing costs which are borne by the Portfolio. There is no guarantee that the Portfolio’s investment via total return swap will deliver returns in excess of the embedded borrowing costs and, accordingly, the Portfolio’s performance may be less than would be achieved by a direct investment in the underlying referenced asset.
Forward Commitments and When-Issued and Delayed Delivery Securities
The Portfolios may use forward commitments. Forward commitments for the purchase or sale of securities may include purchases on a “when-issued” basis or purchases or sales on a “delayed delivery” basis. In some cases, a forward commitment may be conditioned upon the occurrence of a subsequent event, such as approval and consummation of a merger, corporate reorganization or debt restructuring (i.e., a “when, as and if issued” trade). When forward commitment transactions are negotiated, the price is fixed at the time the commitment is made and the Portfolio assumes the rights and risks of ownership of the security but the Portfolio does not pay for the securities until they are received. If the Portfolio is fully or almost fully invested when forward commitment purchases are outstanding, such purchases may result in a form of leverage. Leveraging the portfolio in this manner may increase the Portfolio’s volatility of returns.
When-issued securities and forward commitments may be sold prior to the settlement date. If the Portfolio chooses to dispose of the right to acquire a when-issued security prior to its acquisition or dispose of its right to deliver or receive against a forward commitment, it may incur a gain or loss. Any significant commitment of Portfolio assets to the purchase of securities on a “when, as and if issued” basis may increase the volatility of the Portfolio’s NAV.
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Forward commitments include “to be announced” (“TBA”) mortgage-backed securities, which are contracts for the purchase or sale of mortgage-backed securities to be delivered at a future agreed-upon date, whereby the specific mortgage pool numbers or the number of pools that will be delivered to fulfill the trade obligation or terms of the contract are unknown at the time of the trade. Subsequent to the time of the trade, a mortgage pool or pools guaranteed by GNMA, FNMA, or FHLMC (including fixed-rate or variable-rate mortgages) are allocated to the TBA mortgage-backed securities transactions.
At the time a Portfolio enters into a forward commitment, it will record the transaction and thereafter reflect the value of the security purchased or, if a sale, the proceeds to be received, in determining its NAV. Any unrealized appreciation or depreciation reflected in such valuation of a “when, as and if issued” security would be canceled in the event that the required conditions did not occur and the trade was canceled.
Purchases of securities on a forward commitment or when-issued basis may involve more risk than other types of purchases. For example, by committing to purchase securities in the future, the Portfolio subjects itself to a risk of loss on such commitments as well as on its portfolio securities. Also, the Portfolio may have to sell assets which have been set aside in order to meet redemptions. In addition, if the Portfolio determines it is advisable as a matter of investment strategy to sell the forward commitment or “when-issued” or “delayed delivery” securities before delivery, the Portfolio may incur a gain or loss because of market fluctuations since the time the commitment to purchase such securities was made. Any such gain or loss would be treated as a capital gain or loss for tax purposes. When the time comes to pay for the securities to be purchased under a forward commitment or on a “when-issued” or “delayed delivery” basis, the Portfolio will meet its obligations from the then-available cash flow or the sale of securities, or, although it would not normally expect to do so, from the sale of the forward commitment or “when-issued” or “delayed delivery” securities themselves (which may have a value greater or less than the Portfolio’s payment obligation). No interest or dividends accrue to the purchaser prior to the settlement date for securities purchased or sold under a forward commitment. In addition, in the event the other party to the transaction files for bankruptcy, becomes insolvent, or defaults on its obligation, the Portfolio may be adversely affected.
General
The successful use of the foregoing investment practices, all of which are highly specialized investment activities, draws upon the Adviser’s special skill and experience with respect to such instruments and usually depends on the Adviser’s ability to forecast interest rate movements correctly. Should interest rates move in an unexpected manner, the Portfolios may not achieve the anticipated benefits of futures contracts, options, interest rate transactions or forward commitment contracts, or may realize losses and thus be in a worse position than if such strategies had not been used. Unlike many exchange-traded futures contracts and options on futures contracts, there are no daily price fluctuation limits with respect to forward contracts, and adverse market movements could therefore continue to an unlimited extent over a period of time. In addition, the correlation between movements in the price of such instruments and movements in the price of the securities hedged or used for cover will not be perfect and could produce unanticipated losses.
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A Portfolio’s ability to dispose of its position in futures contracts, options, interest rate transactions and forward commitment contracts will depend on the availability of liquid markets in such instruments. Markets for all these vehicles with respect to municipal securities are still developing. It is impossible to predict the amount of trading interest that may exist in various types of futures contracts and options on futures contracts. If, for example, a secondary market did not exist with respect to an option purchased or written by a Portfolio over-the-counter, it might not be possible to effect a closing transaction in the option (i.e., dispose of the option) with the result that (i) an option purchased by the Portfolio would have to be exercised in order for the Portfolio to realize any profit and (ii) the Portfolio might not be able to sell portfolio securities covering the option until the option expired or it delivered the underlying security or futures contract upon exercise. No assurance can be given that the Portfolios will be able to utilize these instruments effectively for the purposes set forth above. Furthermore, the Portfolios’ ability to engage in options and futures transactions may be limited by tax considerations.
Borrowings and Leverage
A Portfolio, including, in particular, the High Income Portfolio, may use borrowings for investment purposes subject to its investment policies and procedures and to applicable statutory or regulatory requirements.
Borrowings by a Portfolio result in leveraging of the Portfolio’s shares. Likewise, a Portfolio’s use of certain derivatives may effectively leverage the Portfolio’s portfolio. The Adviser anticipates that the difference between the interest expense paid by the Portfolio on borrowings and the returns on the Portfolio’s investment securities will provide the Portfolio’s shareholders with a potentially higher yield. The Portfolios may use leverage for investment purposes by entering into transactions such as forward contracts and Tender Option Bond (“TOB”) transactions. This means that the Portfolio uses cash made available during the term of these transactions to make investments in other securities.
Utilization of leverage, which is usually considered speculative, involves certain risks to the Portfolio’s shareholders. These include a higher volatility of the NAV of the Portfolio’s shares of common stock and the relatively greater effect of changes in the value of the Portfolio’s portfolio on the NAV of the shares caused by favorable or adverse changes in market conditions or interest rates. In the case of borrowings for investment purposes, so long as the Portfolio is able to realize a net return on the portion of its investment portfolio resulting from leverage that is higher than the interest expense paid on borrowings, the effect of leverage will be to cause the Portfolio’s shareholders to realize higher net return than if the Portfolio were not leveraged. With respect to a Portfolio’s use of certain derivatives that result in leverage of the Portfolio’s shares, if the Portfolio is able to realize a net return on its investments that is higher than the costs of the leverage, the effect of such leverage will be to cause the Portfolio to realize a higher net return than if the Portfolio were not leveraged. If the interest expense on borrowings or other costs of leveraged transactions approach the net return on the Portfolio’s investment portfolio or investments made through leverage, as applicable, the benefit of leverage to the Portfolio’s shareholders will be reduced. If the interest expense on borrowings or other costs of leverage were to exceed the net return to the Portfolio, the Portfolio’s use of leverage would result in a lower rate of net return than if the Portfolio were not leveraged. Similarly, the effect
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of leverage in a declining market could normally be a greater decrease in NAV than if the Portfolio were not leveraged.
During periods of rising short-term interest rates, the interest paid on floaters in TOB transactions would increase, which may adversely affect the Portfolio’s net returns. If rising interest rates coincide with a period of rising long-term rates, the value of long-term municipal bonds purchased with the proceeds of leverage would decline, adversely affecting the Portfolio’s NAV. The value of an inverse floater can be more volatile than the value of other debt securities of comparable maturity and quality. During periods of rising interest rates, the prices of inverse floaters will tend to decline more quickly than those of conventional fixed-rate debt securities. In certain circumstances, adverse changes in interest rates or other events could cause a TOB trust to terminate or collapse, potentially requiring a Portfolio to liquidate longer-term municipal securities at unfavorable prices to meet the Trust’s outstanding obligations.
Certain transactions, such as derivative transactions, forward commitments, reverse repurchase agreements and short sales, involve leverage and may expose a Portfolio to potential losses that, in some cases, may exceed the amount originally invested by the Portfolio.
Rule 18f-4, among other things, permits a fund to treat reverse repurchase transactions (and other similar financing transactions) either as borrowings (subject to asset coverage requirements under the 1940 Act) or as “derivatives transactions” subject to the risk-based limits of Rule 18f-4.
Management Risk – Quantitative Models
The Adviser may use investment techniques that incorporate, or rely upon, quantitative models. These models may not work as intended and may not enable the Portfolio to achieve its investment objective. In addition, certain models may be constructed using data from external providers, and these inputs may be incorrect or incomplete, thus potentially limiting the effectiveness of the models. Finally, the Adviser may change, enhance and update its models and its usage of existing models at its discretion.
Illiquid Securities
A Portfolio will not invest in illiquid securities if immediately after such investment more than 15% of the Portfolio’s net assets would be invested in such securities. Under Rule 22e-4 under the 1940 Act, the term illiquid securities means any security or investment that a Portfolio reasonably expects cannot be sold or disposed of in current market conditions in seven calendar days or less without the sale or disposition significantly changing the market value of the investment.
Mutual funds do not typically hold a significant amount of restricted securities (securities that are subject to restrictions on resale to the general public) or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. A mutual fund may also have to take certain steps or wait a certain amount of time in order to
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remove the transfer restrictions for such restricted securities in order to dispose of them, resulting in additional expense and delay.
Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a “safe harbor” from the registration requirements of the Securities Act for resales of certain securities to qualified institutional buyers (“Rule 144A Securities”). The Portfolios have adopted a liquidity risk management program pursuant to Rule 22e-4 under the 1940 Act and related procedures to categorize each Portfolio’s investments, including Rule 144A Securities, and identify illiquid investments. An insufficient number of qualified institutional buyers interested in purchasing certain restricted securities held by a Portfolio, however, could adversely affect the marketability of such portfolio securities and the Portfolio might be unable to dispose of such securities promptly or at reasonable prices.
Investment in Exchange-Traded Funds and Other Investment Companies
Each of the Portfolios may invest in shares of ETFs, including AB ETFs, subject to the restrictions and limitations of the 1940 Act, or any applicable rules, exemptive orders or regulatory guidance. ETFs are pooled investment vehicles that seek to track the performance of a specific index or implement actively-managed investment strategies. Index ETFs will not track their underlying indices precisely since the ETFs have expenses and may need to hold a portion of their assets in cash, unlike the underlying indices, and the ETFs may not invest in all of the securities in the underlying indices in the same proportion as the indices for varying reasons. Unlike index ETFs, actively-managed ETFs generally seek to outperform a benchmark index and typically have higher expenses than index ETFs, which expenses reduce investment returns. Both index ETFs and actively-managed ETFs may offer exposure to broad investment strategies and across various asset classes, including equity, fixed income, commodities and currencies. A Portfolio will incur transaction costs when buying and selling ETF shares, and indirectly bear the expenses of the ETFs. In addition, the market value of an ETF’s shares, which is based on supply and demand in the market for the ETF’s shares, may differ from its NAV. Accordingly, there may be times when an ETF’s shares trade at a discount or premium to its NAV.
The Portfolios may invest, and have invested from time to time, in investment companies other than ETFs, including AB Mutual Funds, as permitted by the 1940 Act or the rules and regulations or exemptive orders thereunder. The Portfolios intend to invest uninvested cash balances in an affiliated money market fund as permitted by Rule 12d1-1 under the 1940 Act. As with ETF investments, if the Portfolio acquires shares in other investment companies, shareholders would bear, indirectly, the expenses of such investment companies (which may include management and advisory fees), which to the extent not waived or reimbursed, would be in addition to the Portfolio’s expenses. A Portfolio’s investments in other investment companies, including ETFs, subjects the Portfolio indirectly to the underlying risks of those investment companies.
To the extent that a Portfolio is an “acquired fund” for purposes of Rule 12d1-4, the Portfolio intends to limit its investments in the securities of other investment companies and private funds to no more than 10% of its total assets, subject to certain limited exceptions permitted under the Rule.
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Loans of Portfolio Securities
A Portfolio may seek to increase income by lending portfolio securities to brokers, dealers and financial institutions (“borrowers”) to the extent permitted under the 1940 Act or the rules or regulations thereunder (as such statute, rules, or regulations may be amended from time to time) or by guidance regarding, interpretations of, or exemptive orders under, the 1940 Act. Under the securities lending program, all securities loans will be secured continually by cash collateral. Principal risks of lending portfolio securities include that the borrower will fail to return the loaned securities upon termination of the loan and, that the value of the collateral will not be sufficient to replace the loaned securities upon the borrower’s default. In determining whether to lend securities to a particular borrower, the Adviser (subject to the oversight of the Boards) will consider all relevant facts and circumstances, including the creditworthiness of the borrower. The loans would be made only to firms deemed by the Adviser to be creditworthy, and when, in the judgment of the Adviser, the consideration that can be earned currently from securities loans of this type justifies the attendant risk. The Portfolio will be compensated for the loan from a portion of the net return from the interest earned on the cash collateral after a rebate paid to the borrower (which may be a negative amount – i.e., the borrower may pay a fee to the Portfolio in connection with the loan) and payments for fees paid to the securities lending agent and for certain other administrative expenses.
A Portfolio will have the right to call a loan and obtain the securities loaned on notice to the borrower within the normal and customary settlement time for the securities. While securities are on loan, the borrower is obligated to pay a Portfolio amounts equal to any income or other distribution from the securities.
A Portfolio may invest any cash collateral from its securities lending activities in shares of an affiliated money market fund managed by the Adviser and approved by the Board. Any such investment of cash collateral will be subject to the money market fund’s investment risk. A Portfolio may pay reasonable finders’, administrative, and custodial fees in connection with a loan.
A Portfolio will not have the right to vote any securities having voting rights that are loaned. A Portfolio will have the right to recall loaned securities or equivalent securities in order to exercise voting or ownership rights. When a Portfolio lends its securities, its investment performance will continue to reflect the value of securities on loan.
Loan Participations and Assignments
A Portfolio may invest in loans (which may be syndicated) to corporate, governmental or other borrowers (“Loans”), either by participating as co-lender at the time the Loan is originated (“Participations”) or by buying an interest in the Loan in the secondary market from a financial institution or institutional investor (“Assignments”). A Loan is often administered by a bank or other financial institution that acts as agent for all the holders. The financial status of the agent interposed between a Portfolio and a borrower may affect the ability of the Portfolio to receive principal and interest payments.
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The success of a Portfolio’s investment may depend on the skill with which an agent administers the terms of the corporate loan agreements, monitors borrower compliance with covenants, collects principal, interest and fee payments from borrowers and, where necessary, enforces creditor remedies against borrowers. Agents typically have broad discretion in enforcing loan agreements.
A Portfolio’s investment in Participations typically will result in the Portfolio having a contractual relationship only with the financial institution arranging the Loan with the borrower (the “Lender”) and not with the borrower directly. The Portfolio will have the right to receive payments of principal, interest and any fees to which it is entitled only from the Lender selling the Participation and only upon receipt by the Lender of the payments from the borrower. In connection with purchasing Participations, a Portfolio generally will have no right to enforce compliance by the borrower with the terms of the loan agreement relating to the Loan, nor any rights of set-off against the borrower, and a Portfolio may not directly benefit from any collateral supporting the Loan in which it has purchased the Participation. As a result, the Portfolio may be subject to the credit risk of both the borrower and the Lender that is selling the Participation. In the event of the insolvency of the Lender selling a Participation, a Portfolio may be treated as a general creditor of the Lender and may not benefit from any set-off between the Lender and the borrower. Certain Participations may be structured in a manner designed to avoid purchasers of Participations being subject to the credit risk of the Lender with respect to the Participation; but even under such a structure, in the event of the Lender’s insolvency, the Lender’s servicing of the Participation may be delayed and the assignability of the Participation impaired. A Portfolio will acquire Participations only if the Lender interpositioned between the Portfolio and the borrower is a Lender having total assets of more than $25 billion and whose senior unsecured debt is rated investment grade by a NRSRO.
When a Portfolio purchases Assignments from Lenders, it will acquire direct rights against the borrower on the Loan. Because Assignments are arranged through private negotiations between potential assignees and potential assignors, however, the rights and obligations acquired by a Portfolio as the purchaser of an assignment may differ from, and be more limited than, those held by the assigning Lender. The assignability of certain obligations is restricted by the governing documentation as to the nature of the assignee such that the only way in which a Portfolio may acquire an interest in a Loan is through a Participation and not an Assignment.
A Portfolio may have difficulty disposing of Assignments and Participations because to do so it will have to assign such securities to a third party. Because there is no liquid market for such securities, the Portfolio anticipates that such securities could be sold only to a limited number of institutional investors. The lack of a liquid secondary market may have an adverse impact on the value of such securities and a Portfolio’s ability to dispose of particular Assignments or Participations when necessary to meet the Portfolio’s liquidity needs in response to a specific economic event such as a deterioration in the creditworthiness of the borrower. The lack of a liquid secondary market for Assignments and Participations also may make it more difficult for a Portfolio to assign a value to these securities for purposes of valuing the Portfolio’s portfolio and calculating its asset value.
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Loans in which a Portfolio may invest may include participations in “bridge loans”, which are loans taken out by borrowers for a short period (typically less than six months) pending arrangement of more permanent financing through, for example, the issuance of bonds, frequently high-yield bonds issued for the purpose of an acquisition. A Portfolio may also participate in unfunded loan commitments, which are contractual obligations for future funding, and receive a commitment fee based on the amount of the commitment.
Preferred Stock
Each Portfolio may invest in preferred stock. Preferred stock is an equity security that has features of debt because it generally entitles the holder to periodic payments at a fixed rate of return. Preferred stock is subordinated to any debt the issuer has outstanding but has liquidation preference over common stock. Accordingly, preferred stock dividends are not paid until all debt obligations are first met. Preferred stock may be subject to more fluctuations in market value, due to changes in market participants’ perceptions of the issuer’s ability to continue to pay dividends, than debt of the same issuer.
Repurchase Agreements and Buy/Sell Back Transactions
A Portfolio may seek additional income by investing in repurchase agreements; Fund Portfolios and Fund II Portfolios may invest in repurchase agreements pertaining only to U.S. Government securities. A repurchase agreement is an agreement by which a Portfolio purchases a security and obtains a simultaneous commitment from the seller to repurchase the security at an agreed-upon price and date, normally one day or a week later. The purchase and repurchase obligations are transacted under one document. The resale price is greater than the purchase price, reflecting an agreed-upon “interest rate”, which is effective for the period of time the buyer’s money is invested in the security, and which is related to the current market rate of the purchased security rather than its coupon rate. During the term of the repurchase agreement, the Portfolio monitors on a daily basis the market value of the securities subject to the agreement and, if the market value of the securities falls below the resale amount provided under the repurchase agreement, the seller under the repurchase agreement is required to provide additional securities or cash equal to the amount by which the market value of the securities falls below the resale amount. Because a repurchase agreement permits a Portfolio to invest temporarily available cash on a fully-collateralized basis, repurchase agreements permit the Portfolio to earn a return on temporarily available cash while retaining “overnight” flexibility in pursuit of investments of a longer-term nature. Repurchase agreements may exhibit the characteristics of loans by a Portfolio.
The obligation of the seller under the repurchase agreement is not guaranteed, and there is a risk that the seller may fail to repurchase the underlying security, whether because of the seller’s bankruptcy or otherwise. In such event, a Portfolio would attempt to exercise its rights with respect to the underlying security, including possible sale of the securities. The Portfolio may incur various expenses in connection with the exercise of its rights and may be subject to various delays and risks of loss, including (a) possible declines in the value of the underlying securities, (b) possible reduction in levels of income and (c) lack of access to the securities (if they are held through a third-party custodian) and possible inability to enforce the Portfolios’ rights. The Boards have established procedures, which are periodically reviewed by
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the Board, pursuant to which the Adviser monitors the creditworthiness of the dealers with which the Portfolios enter into repurchase agreement transactions.
A Portfolio may enter into buy/sell back transactions, which are similar to repurchase agreements. In this type of transaction, a Portfolio enters a trade to buy securities at one price and simultaneously enters a trade to sell the same securities at another price on a specified date. Similar to a repurchase agreement, the repurchase price is higher than the sale price and reflects current interest rates. Unlike a repurchase agreement, however, the buy/sell back transaction, though done simultaneously, is two separate legal agreements. A buy/sell back transaction also differs from a repurchase agreement in that the seller is not required to provide margin payments if the value of the securities falls below the repurchase price because the transaction is two separate transactions. The Portfolio has the risk of changes in the value of the purchased security during the term of the buy/sell back agreement although these agreements typically provide for the repricing of the original transaction at a new market price if the value of the security changes by a specific amount.
Short Sales
A Portfolio may make short sales of securities or maintain a short position. A short sale is effected by selling a security that the Portfolio does not own, or, if the Portfolio does own such security, it is not to be delivered upon consummation of sale. A short sale is against the box to the extent that the Portfolio contemporaneously owns or has the right to obtain securities identical to those sold. A short sale of a security involves the risk that, instead of declining, the price of the security sold short will rise. If the price of the securities sold short increases between the time of a short sale and the time the Portfolio replaces the borrowed security, the Portfolio will incur a loss; conversely, if the price declines, the Portfolio will realize a gain. The potential for the price of a fixed-income security sold short to rise is a function of both the remaining maturity of the obligation, its creditworthiness and its yield. Unlike short sales of equities or other instruments, the potential for the price of a fixed-income security to rise may be limited due to the fact that the security will be no more than par at maturity. However, the short sale of other instruments or securities generally, including fixed-income securities convertible into equities or other instruments, a fixed-income security trading at a deep discount from par or which pays a coupon that is high in relative or absolute terms, or which is denominated in a currency other than the U.S. Dollar, involves the possibility of a theoretically unlimited loss since there is a theoretically unlimited potential for the market price of the security sold short to increase.
Structured Products
A Portfolio may invest in structured products. Structured products, including indexed or structured securities, combine the elements of futures contracts or options with those of debt, preferred equity or a depositary instrument. Generally, the principal amount, amount payable upon maturity or redemption, or interest rate of a structured product is tied (either positively or negatively) to prices, changes in prices, or differences between prices, of underlying assets, such as securities, currencies, intangibles, goods, articles or commodities or by reference to an unrelated benchmark related to an objective index, economic factor or other measure, such as interest rates, currency exchange rates, commodity indices, and securities indices. The
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interest rate or (unlike most fixed-income securities) the principal amount payable at maturity of a structured product may be increased or decreased depending on changes in the value of the underlying asset or benchmark.
Structured products may take a variety of forms. Most commonly, they are in the form of debt instruments with interest or principal payments or redemption terms determined by reference to the value of a currency or commodity or securities index at a future point in time, but may also be issued as preferred stock with dividend rates determined by reference to the value of a currency or convertible securities with the conversion terms related to a particular commodity.
Investing in structured products may be more efficient and less expensive for a Portfolio than investing in the underlying assets or benchmarks and the related derivative. These investments can be used as a means of pursuing a variety of investment goals, including currency hedging, duration management and increased total return. In addition, structured products may be a tax-advantaged investment in that they generate income that may be distributed to shareholders as income rather than short-term capital gains that may otherwise result from a derivatives transaction.
Structured products, however, have more risk than traditional types of debt or other securities. These products may not bear interest or pay dividends. The value of a structured product or its interest rate may be a multiple of a benchmark and, as a result, may be leveraged and move (up or down) more steeply and rapidly than the benchmark. Under certain conditions, the redemption value of a structured product could be zero. Structured products are potentially more volatile and carry greater market risks than traditional debt instruments. The prices of the structured instrument and the benchmark or underlying asset may not move in the same direction or at the same time. Structured products may carry greater trading risk and be more difficult to price than less complex securities or instruments or more traditional debt securities. The risk of these investments can be substantial with the possibility that the entire principal amount is at risk. The purchase of structured products also exposes a Portfolio to the credit risk of the issuer of the structured product.
Structured Notes and Indexed Securities: A Portfolio may invest in a particular type of structured instrument sometimes referred to as a “structured note”. The terms of these notes may be structured by the issuer and the purchaser of the note. Structured notes are derivative debt instruments, the interest rate or principal of which is determined by an unrelated indicator (for example, a currency, security, commodity or index thereof). Indexed securities may include structured notes as well as securities other than debt securities, the interest rate or principal of which is determined by an unrelated indicator. The terms of structured notes and indexed securities may provide that in certain circumstances no principal is due at maturity, which may result in a total loss of invested capital. Structured notes and indexed securities may be positively or negatively indexed, so that appreciation of the unrelated indicator may produce an increase or a decrease in the interest rate or the value of the structured note or indexed security at maturity may be calculated as a specified multiple of the change in the value of the unrelated indicator. Therefore, the value of such notes and securities may be very volatile. Structured notes and indexed securities may entail a greater degree of market risk than other types of debt securities because the investor bears the risk of the unrelated indicator. Structured
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notes or indexed securities also may be more volatile, carry greater trading risk, and be more difficult to accurately price than less complex securities and instruments or more traditional debt securities.
Credit-Linked Securities: Credit-linked securities are issued by a limited purpose trust or other vehicle that, in turn, invests in a basket of derivative instruments, such as credit default swaps, interest rate swaps and other securities, in order to provide exposure to certain high-yield or other fixed-income markets. For example, a Portfolio may invest in credit-linked securities as a cash management tool in order to gain exposure to certain high-yield markets and/or to remain fully invested when more traditional income-producing securities are not available. Like an investment in a bond, investments in credit-linked securities represent the right to receive periodic income payments (in the form of distributions) and payment of principal at the end of the term of the security. However, these payments are conditioned on the trust’s receipt of payments from, and the trust’s potential obligations to, the counterparties to the derivative instruments and other securities in which the trust invests. For instance, the trust may sell one or more credit default swaps, under which the trust would receive a stream of payments over the term of the swap agreements provided that no event of default has occurred with respect to the referenced debt obligation upon which the swap is based. If a default occurs, the stream of payments may stop and the trust would be obligated to pay the counterparty the par value (or other agreed-upon value) of the referenced debt obligation. This, in turn, would reduce the amount of income and principal that a Portfolio would receive as an investor in the trust. A Portfolio’s investments in these instruments are indirectly subject to the risks associated with derivative instruments, including, among others, credit risk, default or similar event risk, counterparty risk, interest rate risk, leverage risk and management risk. These securities are generally Rule 144A Securities and therefore may be freely traded among qualified institutional buyers. However, changes in the market for credit-linked securities or the availability of willing buyers may result in reduced liquidity for the securities.
Tender Option Bond Transactions
A Portfolio may enter into and has, from time to time, entered into TOB transactions in which the Portfolio transfers municipal securities into a special purpose entity (the “Trust”). The Portfolio receives cash and a residual interest security (sometimes referred to as “inverse floaters”) issued by the Trust in return. The Trust simultaneously issues securities, which pay an interest rate that is reset each week based on an index of high-grade short-term demand notes. These securities, sometimes referred to as “floaters”, are bought by third parties, including tax-exempt money market funds, and can be tendered by these holders to a liquidity provider at par, unless certain events occur. The floaters typically have first priority on the cash flow from the underlying municipal securities held by the Trust, and the remaining cash flow, less certain expenses, is paid to holders of the inverse floaters. The interest rate payable on the inverse floaters bears an inverse relationship to the interest rate on the floaters. Under certain circumstances, the Trust may be terminated or collapsed, either by the Portfolio or upon the occurrence of certain events, such as a downgrade in the credit quality of the underlying municipal securities or in the event holders of the floaters tender their securities to the liquidity provider. The Portfolio continues to earn all the interest from the transferred municipal securities less the amount of interest paid on the floaters and the expenses of the Trust, which may include payments to the trustee and the liquidity provider and organizational costs. The
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Portfolio receives cash proceeds from the Trust’s sale of the floaters as consideration for the transferred municipal securities and uses the cash proceeds for investment purposes (e.g., the purchase of longer-term municipal securities), which involves leverage risk.
A Portfolio, as the holder of the residual inverse floaters, has full exposure to any increase or decrease in the value of the Trust’s underlying municipal securities. Inverse floaters generally will underperform the market of fixed-rate debt securities in a rising interest rate environment (i.e., when bond values are falling), but will tend to outperform the market of fixed-rate debt securities when interest rates decline or remain relatively stable. The price of the inverse floaters will be more volatile than that of the underlying municipal securities because the interest rate is dependent on not only the fixed coupon rate of the underlying municipal securities, but also on the short-term interest rate paid on the floaters. Although volatile in value and return, inverse floaters typically offer the potential for yields higher than those available on fixed-rate debt securities with comparable credit quality, call provisions and maturity.
Service providers are often engaged to assist with establishing, structuring and sponsoring TOB trusts. The service providers, such as administrators, liquidity providers, trustees and remarketing agents, may act at the direction of, and as agent of, a fund holding residual interests of the TOB trust. To the extent a Portfolio, rather than a third-party bank or financial institution serves as the sponsor of a TOB trust, the Portfolio’s responsibilities under such an arrangement may give rise to certain risks including compliance, securities laws and operational risks.
U.S. Government Securities
U.S. Government securities may be backed by the full faith and credit of the United States, supported only by the right of the issuer to borrow from the U.S. Treasury or backed only by the credit of the issuing agency itself. These securities include: (i) the following U.S. Treasury securities, which are backed by the full faith and credit of the United States and differ only in their interest rates, maturities and times of issuance: U.S. Treasury bills (maturities of one year or less with no interest paid and hence issued at a discount and repaid at full face value upon maturity), U.S. Treasury notes (maturities of one to ten years with interest payable every six months) and U.S. Treasury bonds (generally maturities of greater than ten years with interest payable every six months); (ii) obligations issued or guaranteed by U.S. Government agencies and instrumentalities that are supported by the full faith and credit of the U.S. Government, such as securities issued by GNMA, the Department of Housing and Urban Development, the Export-Import Bank, the General Services Administration, the Small Business Administration and obligations that are issued by private issuers that are guaranteed as to principal or interest by the U.S. Government, its agencies or instrumentalities; and (iii) obligations issued or guaranteed by U.S. Government agencies and instrumentalities that were historically not supported by the full faith and credit of the U.S. Government or a right to borrow from the U.S. Treasury, such as securities issued by the FNMA and FHLMC, and governmental CMOs. The maturities of the U.S. Government securities listed in paragraphs (i) and (ii) above usually range from three months to 30 years. Such securities, except GNMA certificates, normally provide for periodic payments of interest in fixed amounts with principal payments at maturity or specified call dates.
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U.S. Government securities also include zero-coupon securities and principal-only securities and certain stripped mortgage-related securities. Zero-coupon securities are described in more detail in “Zero-Coupon Securities” below, and stripped mortgage-related securities and principal-only securities are described in more detail in “Asset-backed Securities, Mortgage-Related Securities and Structured Securities” above. In addition, other U.S. Government agencies and instrumentalities have issued stripped securities that are similar to SMRS.
Inflation-indexed securities, or IPS, such as Treasury Inflation-Protected Securities, or TIPS, are fixed-income securities whose value is periodically adjusted according to the rate of inflation. If the index measuring inflation falls, the principal value of these securities will be adjusted downward, and consequently the interest payable on these securities (calculated with respect to a smaller principal amount) will be reduced. Repayment of the original bond principal upon maturity (as adjusted for inflation) is guaranteed in the case of U.S. Treasury inflation-protected securities. For bonds that do not provide a similar guarantee, the adjusted principal value of the bond repaid at maturity may be less than the original principal.
Inflation-indexed securities tend to react to changes in real interest rates. In general, the price of an inflation-indexed debt security can fall when real interest rates rise, and can rise when real interest rates fall. In addition, the value of inflation-indexed securities may be vulnerable to changes in expectations of inflation. Interest payments on inflation-indexed debt securities can be unpredictable and will vary as the principal and/or interest is adjusted for inflation.
TIPS, which are issued by the U.S Treasury, use the Consumer Price Index for All Urban Consumers, or the CPI, as the inflation measure. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the CPI. When a TIPS matures, the holder is paid the adjusted principal or original principal, whichever is greater. TIPS pay interest twice a year, at a fixed rate, which is determined by auction at the time the TIPS are issued. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation. TIPS are issued in terms of 5, 10, and 30 years.
Guarantees of securities by the U.S. Government or its agencies or instrumentalities guarantee only the payment of principal and interest on the securities, and do not guarantee the securities’ yield or value or the yield or value of the shares of the Portfolio that holds the securities.
U.S. Government securities are considered among the safest of fixed-income investments. As a result, however, their yields are generally lower than the yields available from other fixed-income securities.
Variable, Floating and Inverse Floating-Rate Municipal or Other Fixed-Income Securities
These securities have interest rates that are reset at periodic intervals, usually by reference to some interest rate index or market interest rate. Although the rate adjustment feature may act as a buffer to reduce sharp changes in the value of these securities, they are still subject to changes in value based on changes in market interest rates or changes in the issuer’s creditworthiness. Because the interest rate is reset only periodically, changes in the interest rate
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on these securities may lag behind changes in prevailing market interest rates. Also, some of these securities (or the underlying mortgages) are subject to caps or floors that limit the maximum change in the interest rate during a specified period or over the life of the security.
Zero-Coupon Municipal or Other Securities
A zero-coupon security pays no interest to its holder during its life. An investor acquires a zero-coupon security at a discounted price from the face value of the security, which is generally based upon its present value, and which, depending upon the time remaining until maturity, may be significantly less than its face value (sometimes referred to as a “deep discount” price). Upon maturity of the zero-coupon security, the investor receives the face value of the security.
A Portfolio may invest in zero-coupon Treasury securities, which consist of Treasury bills or the principal components of U.S. Treasury bonds or notes. The Portfolio may also invest in zero-coupon securities issued by U.S. Government agencies or instrumentalities that are supported by the full faith and credit of the United States, which consist of the principal components of securities of U.S. Government agencies or instrumentalities.
Currently, the only U.S. Treasury security issued without coupons is the Treasury bill. The zero-coupon securities purchased by the Portfolio may consist of principal components held in STRIPS form issued through the U.S. Treasury’s STRIPS program, which permits the beneficial ownership of the component to be recorded directly in the Treasury book-entry system. In addition, a number of banks and brokerage firms have separated (“stripped”) the principal portion (“corpus”) from the coupon portion of U.S. Treasury bonds and notes and sold them separately in the form of receipts or certificates representing undivided interests in these instruments (which instruments are generally held by a bank in a custodial or trust account).
Because zero-coupon securities trade at a discount from their face or par value but pay no periodic interest, they are subject to greater fluctuations of market value in response to changing interest rates than debt obligations of comparable maturities which make periodic distributions of interest.
Current federal tax law requires that a holder (such as a Portfolio) of a zero-coupon security accrue a portion of the discount at which the security was purchased as income each year even though the holder receives no interest payment in cash on the security during the year (generally referred to as “original issue discount” or “OID”). As a result, in order to make the distributions necessary for the Portfolio not to be subject to federal income or excise taxes, a Portfolio may be required to pay out as an income distribution each year an amount greater than the total amount of cash that the Portfolio has actually received as interest during the year, and this distribution of “phantom income” may be taxable to shareholders. A Portfolio’s obligation to make such distributions could require it to liquidate other investments at times when the Adviser would not otherwise deem it advisable to do so (potentially resulting in taxable gain), or borrow money, and either of these options could reduce fund assets available to purchase other income-producing securities. The Portfolios believe, however, that it is highly unlikely that it would be necessary to liquidate portfolio securities or borrow money in order to make such required distributions or to meet their investment objectives.
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Custodial Receipts
Custodial receipts, which may be underwritten by securities dealers or banks, represent the right to receive certain future principal and/or interest payments on the underlying securities held by the custodian, or, in some cases, the payment obligation of a third party that has entered into an interest rate swap or other arrangement with the custodian. Underlying securities may include municipal securities, U.S. Government securities or other types of securities consistent with a Portfolio’s investment objective and principal investment strategy. Custodial receipts may be issued in connection with the restructuring of insured municipal bonds deposited with a custodian. The value of a custodial receipt may fluctuate more than the value of a municipal bond of comparable quality and maturity.
In a typical custodial receipt arrangement, an issuer or a third-party owner of securities deposits such securities obligations with a custodian in exchange for custodial receipts. These custodial receipts are typically sold in private placements and are designed to provide investors with pro rata ownership of a portfolio of underlying securities. For certain securities law purposes, custodial receipts may not be considered obligations of the issuers of the underlying securities held by the custodian. As a holder of custodial receipts, a Portfolio will bear its proportionate share of the fees and expenses charged to the custodial account. Although under the terms of a custodial receipt a Portfolio typically would be authorized to assert its rights directly against the issuer of the underlying obligation, the Portfolio could be required to assert through the custodian bank those rights as may exist against the underlying issuers. Thus, in the event an underlying issuer fails to pay principal and/or interest when due, the Portfolio may be subject to delays, expenses and risks that are greater than those that would have been involved if the Portfolio had purchased a direct obligation of the issuer. In addition, if for tax purposes a Portfolio is not considered to be the owner of the underlying securities held in the custodial account, the Portfolio may suffer adverse tax consequences.
Certain custodial receipts may be synthetic or derivative instruments that have interest rates that reset inversely to changing short-term rates and/or have embedded interest rate floors and caps that require the issuer to pay an adjusted interest rate if market rates fall below or rise above a specified rate. Because some of these instruments represent relatively recent innovations, and the trading market for these instruments is less developed than the markets for more traditional types of instruments, it is uncertain how these instruments will perform under different economic and interest-rate scenarios. In addition, because these instruments may be leveraged, their market values may be more volatile than other types of fixed-income instruments and may present greater potential for capital gain or loss. The possibility of default by an issuer or the issuer's credit provider may be greater for these derivative instruments than for other types of instruments. In some cases, it may be difficult to determine the fair value of a derivative instrument because of a lack of reliable objective information and an established secondary market for some instruments may not exist.
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Future Developments
A Portfolio may take advantage of other investment practices which are not at present contemplated for use by the Portfolio or which currently are not available but which may be developed, to the extent such investment practices are both consistent with the Portfolio’s investment objective and legally permissible for the Portfolio. Such investment practices, if they arise, may involve risks which exceed those involved in the activities described above.
Special Risk Considerations
The ratings of fixed-income securities by NRSROs such as Moody’s, S&P, Fitch, Kroll Bond Rating Agency, LLC (“Kroll”) and DBRS Morningstar are widely accepted barometers of credit risk. They are, however, subject to certain limitations from an investor’s standpoint. The rating of an issuer is heavily weighted by past developments and does not necessarily reflect probable future conditions. There is frequently a lag between the time a rating is assigned and the time it is updated. In addition, there may be varying degrees of differences in credit risk of securities within each rating category. See Appendix A for a description of such ratings.
Many fixed-income securities, including certain municipal securities in which a Portfolio may invest, contain call or buy-back features that permit the issuer of the security to call or repurchase it. Such securities may present risks based on payment expectations. If an issuer exercises such a “call option” and redeems the security, the Portfolio may have to replace the called security with a lower yielding security, resulting in a decreased rate of return for the Portfolio.
Non-rated municipal or other fixed-income securities will also be considered for investment by the Portfolio when the Adviser believes that the financial condition of the issuers of such obligations and the protection afforded by the terms of the obligations themselves limit the risk to the Portfolio to a degree comparable to that of rated securities which are consistent with the Portfolio’s objective and policies.
A Portfolio may invest in lower-rated securities (commonly referred to as “junk bonds”), which may include securities having the lowest rating for non-subordinated debt securities by a NRSRO and unrated securities of equivalent investment quality. Debt securities with such a rating are considered by NRSROs to be subject to greater risk of loss of principal and interest than higher-rated securities and are considered to be predominantly speculative with respect to the issuer’s capacity to pay interest and repay principal, which may in any case decline during sustained periods of deteriorating economic conditions or rising interest rates. These securities are considered to have extremely poor prospects of ever attaining any real investment standing, to have a current identifiable vulnerability to default, to be unlikely to have the capacity to pay interest and repay principal when due in the event of adverse business, financial or economic conditions, and/or to be in default or not current in the payment of interest or principal.
Lower-rated securities generally are considered to be subject to greater market risk than higher-rated securities in times of deteriorating economic conditions. In addition, lower-rated securities may be more susceptible to real or perceived adverse economic and competitive industry conditions than investment grade securities, although the market values of
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securities rated below investment grade and comparable unrated securities tend to react less to fluctuations in interest rate levels than do those of higher-rated securities. The market for lower-rated securities may be thinner and less active than that for higher-quality securities, which can adversely affect the prices at which these securities can be sold. To the extent that there is no established secondary market for lower-rated securities, the Adviser may experience difficulty in valuing such securities and, in turn, a Portfolio’s assets. In addition, adverse publicity and investor perceptions about lower-rated securities, whether or not based on fundamental analysis, may tend to decrease the market value and liquidity of such lower-rated securities. Transaction costs with respect to lower-rated securities may be higher, and in some cases information may be less available, than is the case with investment grade securities.
In seeking to achieve a Portfolio’s objective, there will be times, such as during periods of rising interest rates, when depreciation and realization of capital losses on securities in the Portfolio will be unavoidable. Moreover, medium- and lower-rated securities and non-rated securities of comparable quality may be subject to wider fluctuations in yield and market values than higher-rated securities under certain market conditions. Such fluctuations after a security is acquired do not affect the cash income received from that security but are reflected in the NAV of the Portfolio.
Merger, Reorganization, or Liquidation of a Portfolio. To the extent permitted by law, a Board may determine to merge or reorganize a Portfolio or a share class, or to close and liquidate a Portfolio or a share class at any time, which may have adverse consequences for shareholders. In the case of a liquidation of a Portfolio or share class, shareholders are expected to receive a liquidating distribution in cash or in-kind equal to their proportionate interest in the Portfolio or the class, as applicable. In the event the Board determines to liquidate a Portfolio or a share class, the timing of the liquidation might not be the most favorable to certain shareholders. A liquidating distribution may be a taxable event to certain shareholders, resulting in a taxable gain or loss for tax purposes, depending upon a shareholder’s basis in the shareholder’s shares of the Portfolio. A shareholder may receive an amount in liquidation less than the shareholder’s original investment.
Participation in Legal and Other Activities
A Portfolio may, directly or indirectly, seek to assert its rights as a shareholder, bondholder or owner of interests or assets in an issuer in which the Portfolio has invested, including through instituting legal actions against the issuer and related parties. To the extent it engages in these activities, the Portfolio could incur certain expenses (such as legal, consulting, and similar expenses) that it may not recoup through the investment, and such expenses could increase the Portfolio’s operating expenses or cost basis of the investment and could adversely affect its investment and the Portfolio’s net asset value. From time to time, a Portfolio may seek to reduce or eliminate these expenses by coordinating its activities with other investors or by agreeing with a party engaged to fund the legal action to reduce any potential recovery from the matter to compensate such party for its services.
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INVESTMENT RESTRICTIONS
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Fundamental Investment Policies
The following fundamental investment policies may not be changed with respect to any Portfolio without the affirmative vote of the holders of a majority of such Portfolio’s outstanding voting securities, which means with respect to any such Portfolio (1) 67% or more of the shares of the Portfolio represented at a meeting at which more than 50% of the outstanding shares are present in person or by proxy or (2) more than 50% of the outstanding shares of the Portfolio, whichever is less.
As a matter of fundamental policy, a Portfolio may not:
(1) | concentrate investments in an industry, as concentration may be defined under the 1940 Act or the rules and regulations thereunder (as such statute, rules or regulations may be amended from time to time) or by guidance regarding, interpretations of, or exemptive orders under, the 1940 Act or the rules or regulations thereunder published by appropriate regulatory authorities; |
(2) | issue any senior security (as that term is defined in the 1940 Act) or borrow money, except to the extent permitted by the 1940 Act or the rules and regulations thereunder (as such statute, rules or regulations may be amended from time to time) or by guidance regarding, or interpretations of, or exemptive orders under, the 1940 Act or the rules or regulations thereunder published by appropriate regulatory authorities; |
(3) | make loans except through (i) the purchase of debt obligations in accordance with its investment objectives and policies; (ii) the lending of portfolio securities; (iii) the use of repurchase agreements; or (iv) the making of loans to affiliated funds as permitted under the 1940 Act, the rules and regulations thereunder (as such statutes, rules or regulations may be amended from time to time), or by guidance regarding, and interpretations of, or exemptive orders under, the 1940 Act; |
(4) | act as an underwriter of securities, except that a Portfolio may acquire restricted securities under circumstances in which, if such securities were sold, the Portfolio might be deemed to be an underwriter for purposes of the Securities Act; or |
(5) | purchase or sell real estate except that it may dispose of real estate acquired as a result of the ownership of securities or other instruments. This restriction does not prohibit a Portfolio from investing in securities or other instruments backed by real estate or in securities of companies engaged in the real estate business. |
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As a fundamental policy, Arizona, Massachusetts, New Jersey, New York and Ohio Portfolios may not purchase or sell commodities regulated by the CFTC under the CEA or commodities contracts except for futures contracts and options on futures contracts.
As a fundamental policy, National, High Income, California, Minnesota, Pennsylvania and Virginia Portfolios may purchase or sell commodities or options thereon to the extent permitted by applicable law.
As a fundamental policy, each Portfolio is diversified (as that term is defined in the 1940 Act). This means that at least 75% of a Portfolio’s assets consists of: (i) cash or cash items; (ii) government securities; (iii) securities of other investment companies; and (iv) securities of any one issuer that represent no more than 10% of the outstanding voting securities of the issuer of the securities and not more than 5% of the total assets of a Portfolio.
Non-Fundamental Investment Policy
The following is a description of an operating policy that the Portfolios have adopted but that is not fundamental and subject to change without shareholder approval.
The Portfolios may not purchase securities on margin, except (i) as otherwise provided under rules adopted by the SEC under the 1940 Act or by guidance regarding the 1940 Act, or interpretations thereof, and (ii) that the Portfolios may obtain such short-term credits as are necessary for the clearance of portfolio transactions, and the Portfolios may make margin payments in connection with futures contracts, options, forward contracts, swaps, caps, floors, collars and other financial instruments.
MANAGEMENT OF THE FUNDS
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Adviser
The Adviser, a Delaware limited partnership with principal offices at 501 Commerce Street, Nashville, TN 37203, has been retained under investment advisory agreements (the “Advisory Agreements”) to provide investment advice and, in general, to conduct the management and investment program of the Funds under the supervision of the Funds’ Boards (see “Management of the Portfolios” in the Prospectus). The Adviser is an investment adviser registered under the Investment Advisers Act of 1940, as amended.
The Adviser is a leading global investment management firm supervising client accounts with assets as of June 30, 2024, totaling approximately $769 billion. The Adviser provides management services for many of the largest U.S. public and private employee benefit plans, endowments, foundations, public employee retirement funds, banks, insurance companies and high net worth individuals worldwide.
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As of June 30, 2024, the ownership structure of the Adviser, expressed as a percentage of general and limited partnership interests, was as follows:
Equitable Holdings and its subsidiaries | 59.7 | % | ||
AllianceBernstein Holding, L.P. | 39.6 | |||
Unaffiliated holders | 0.7 | |||
100.0 | % |
Equitable Holdings, Inc. (formerly named AXA Equitable Holdings, Inc.) (“EQH”) is a leading financial services company in the U.S. and consists of two well-established principal franchises, Equitable Financial Life Insurance Company and AllianceBernstein.
As of June 30, 2024, EQH owned approximately 3.5% of the issued and outstanding units representing assignments of beneficial ownership of limited partnership interests in AllianceBernstein Holding LP (“AB Holding”). AllianceBernstein Corporation (an indirect wholly-owned subsidiary of EQH, “GP”) is the general partner of both AB Holding and the Adviser. The GP owns 100,000 general partnership units in AB Holding and a 1% general partnership interest in the Adviser.
Including both the general partnership and limited partnership interests in AB Holding and the Adviser, EQH and its subsidiaries have an approximate 61.1% economic interest in the Adviser as of June 30, 2024.
During the second quarter of 2018, AXA S.A. (“AXA”), a French holding company for the AXA Group, completed the sale of a minority stake in EQH through an initial public offering. Since the initial sale, AXA has completed additional offerings (and related transactions). As a result, as of May 20, 2021, AXA no longer owns shares of EQH.
Sales that were completed on November 13, 2019 resulted in the indirect transfer of a “controlling block” of voting securities of the Adviser (a “Change of Control Event”) and may have been deemed to have been an “assignment” causing a termination of each Fund’s investment advisory agreement, with respect to the Portfolios. In order to ensure that the investment advisory services could continue uninterrupted in the event of a Change of Control Event, the Boards previously approved new investment advisory agreements with the Adviser, and shareholders of the Portfolios subsequently approved the new investment advisory agreements. These agreements became effective on November 13, 2019.
Advisory Agreements and Expenses
Under the Advisory Agreements, the Adviser furnishes advice and recommendations with respect to the portfolios of securities and investments and provides persons satisfactory to the Boards to act as officers and employees of the Portfolios. Such officers and employees, as well as certain directors or trustees of the Portfolios, may be employees of the Adviser or its affiliates.
The Adviser is, under the Advisory Agreements, responsible for certain expenses incurred by the Portfolios including, for example, office facilities, and any expenses incurred in
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promoting the sale of Fund shares (other than the portion of the promotional expenses borne by the Funds in accordance with an effective plan pursuant to Rule 12b-1 under the 1940 Act, and the costs of printing Fund prospectuses and other reports to shareholders and fees related to registration with the SEC and with state regulatory authorities).
The Funds have under the Advisory Agreements assumed the obligation for payment of all of their other expenses. As to the obtaining of services other than those specifically provided to the Portfolios by the Adviser, each Portfolio may employ its own personnel. The Advisory Agreements provide for reimbursement to the Adviser of the costs of certain non-advisory services provided to a Portfolio. Costs currently reimbursed include the costs of the Adviser’s personnel performing certain administrative services for the Portfolios, including clerical, accounting, legal and other services (“administrative services”), and associated overhead costs, such as office space, supplies and information technology. The administrative services are provided to the Portfolios on a fully-costed basis (i.e., includes each person’s total compensation and a factor reflecting the Adviser’s total cost relating to that person, including all related overhead expenses). The reimbursement of these costs to the Adviser will be specifically approved by the Boards. For the fiscal year ended May 31, 2024, the National, California, High Income, New York, Arizona, Massachusetts, New Jersey and Virginia Portfolios paid the Adviser $94,360, $87,513, $101,713, $102,424, $70,120, $77,228, $74,511 and $77,870, respectively, for these services. The Adviser agreed to voluntarily waive such fees in the amount of $79,569, $79,569 and $80,751 for Minnesota, Ohio and Pennsylvania, respectively, for the fiscal year ended May 31, 2024.
The Advisory Agreements continue in effect from year to year, with respect to each Portfolio, provided that such continuance is specifically approved at least annually by a majority vote of the holders of the outstanding voting securities of such Portfolio or by a majority vote of the Fund’s Directors or Trustees (the “Directors”), and, in either case, by a majority of the Directors who are not parties to the Advisory Agreements or interested persons of any such party as defined by the 1940 Act. Most recently, continuance of the Advisory Agreement for each Portfolio was approved for an additional annual term by a vote of the Board at its meetings held on July 30-31, 2024.
Any material amendment to the Advisory Agreements must be approved by a vote of a majority of outstanding securities of the relevant Portfolios and by the vote of a majority of the Directors who are not interested persons of the Portfolio or the Adviser.
The Advisory Agreements are terminable with respect to a Portfolio without penalty by a vote of a majority of the Portfolio’s outstanding voting securities or by a vote of a majority of the Directors on 60 days’ written notice, or by the Adviser on 60 days’ written notice, and will automatically terminate in the event of its assignment. The Advisory Agreements provide that in the absence of willful misfeasance, bad faith or gross negligence on the part of the Adviser, or of reckless disregard of its obligations thereunder, the Adviser shall not be liable for any action or failure to act in accordance with its duties thereunder.
Under the terms of the Advisory Agreements, the Portfolios, except the High Income Portfolio, pay the Adviser .45 of 1% of the first $2.5 billion, .40 of 1% of the excess over $2.5 billion up to $5 billion and .35 of 1% of the excess over $5 billion of each Portfolio’s average daily net assets and the High Income Portfolio pays the Adviser a contractual advisory
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fee of .50 of 1.00% of the first $2.5 billon, .45 of 1.00% of the excess over $2.5 billon up to $5 billion and .40 of 1.00% of the excess over $5 billion of the Portfolio’s average daily net assets. Such fees are accrued daily and paid monthly.
With respect to the Fund Portfolios and Fund II Portfolios, the Adviser has contractually agreed for the period from the effective date of the Portfolio’s Prospectus to the effective date of the subsequent Prospectus incorporating the Portfolio’s annual financial statements (the “Period”) to waive its fee and bear certain expenses so that total operational expenses (excluding acquired fund fees and expenses other than the advisory fees of any AB Fund in which the Portfolio may invest, interest expense, and extraordinary expenses) do not exceed the amounts noted for the Portfolios listed in the table below. The fee waiver and/or expense reimbursement agreements will remain in effect until September 30, 2025 and may only be terminated or changed with the consent of the Fund’s Directors. In addition, these fee waiver and/or expense reimbursement agreements automatically extend each year unless the Adviser provides notice 60 days prior to the end of the Period.
Portfolio | Share Class | Expense Cap |
National | Class A | 0.75% |
Class C | 1.50% | |
Advisor Class | 0.50% | |
High Income | Class A | 0.80% |
Class C | 1.55% | |
Advisor Class | 0.55% | |
Class Z | 0.55% | |
California | Class A | 0.75% |
Class C | 1.50% | |
Advisor Class | 0.50% | |
New York | Class A | 0.75% |
Class C | 1.50% | |
Advisor Class | 0.50% |
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Portfolio | Share Class | Expense Cap |
Arizona | Class A | 0.78% |
Class C | 1.53% | |
Advisor Class | 0.53% | |
Massachusetts | Class A | 0.77% |
Class C | 1.52% | |
Advisor Class | 0.52% | |
Minnesota | Class A | 0.85% |
Class C | 1.60% | |
New Jersey | Class A | 0.82% |
Class C | 1.57% | |
Ohio | Class A | 0.80% |
Class C | 1.55% | |
Pennsylvania | Class A | 0.85% |
Class C | 1.60% | |
Virginia | Class A | 0.80% |
Class C | 1.55% | |
Advisor Class | 0.55% | |
For the three most recent fiscal years, the Adviser earned advisory fees and the Adviser waived fees/reimbursed expenses as follows:
Portfolio | Advisory Fees |
Amounts Waived and/or Reimbursed under Fee Waiver and/or Expense Reimbursement Agreement | ||
National | ||||
2024 | $8,017,019 | $565,373 | ||
2023 | 7,714,627 | 711,559 | ||
2022 | 8,385,863 | 343,031 | ||
High Income | ||||
2024 | $14,212,246 | $241,276 | ||
2023 | 15,210,201 | 246,328 | ||
2022 | 18,418,765 | 0 |
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Portfolio | Advisory Fees |
Amounts Waived and/or Reimbursed under Fee Waiver and/or Expense Reimbursement Agreement | ||
New York | ||||
2024 | $2,296,784 | $362,767 | ||
2023 | 2,432,672 | 392,464 | ||
2022 | 2,912,135 | 263,579 | ||
California | ||||
2024 | $4,835,589 | $215,312 | ||
2023 | 4,328,324 | 289,487 | ||
2022 | 4,778,652 | 132,375 | ||
Arizona | ||||
2024 | $385,161 | $255,811 | ||
2023 | 451,531 | 290,877 | ||
2022 | 536,734 | 250,325 | ||
Massachusetts | ||||
2024 | $996,094 | $257,065 | ||
2023 | 934,815 | 270,022 | ||
2022 | 999,031 | 220,791 | ||
Minnesota | ||||
2024 | $148,127 | $156,986 | ||
2023 | 180,259 | 184,195 | ||
2022 | 251,688 | 141,446 | ||
New Jersey | ||||
2024 | $279,672 | $239,289 | ||
2023 | 271,110 | 216,051 | ||
2022 | 314,918 | 225,036 |
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Portfolio | Advisory Fees |
Amounts Waived and/or Reimbursed under Fee Waiver and/or Expense Reimbursement Agreement | ||
Ohio | ||||
2024 | $214,451 | $180,475 | ||
2023 | 258,302 | 232,136 | ||
2022 | 322,744 | 246,078 | ||
Pennsylvania | ||||
2024 | $220,931 | $166,755 | ||
2023 | 238,588 | 207,143 | ||
2022 | 296,438 | 215,632 | ||
Virginia | ||||
2024 | $903,864 | $183,193 | ||
2023 | 926,055 | 220,369 | ||
2022 | 1,081,999 | 146,042 |
To the extent that a Portfolio invests in AB Government Money Market Portfolio (except for the investment of any cash collateral from securities lending), the Adviser has contractually agreed to waive its management fee from the Portfolio and/or reimburse other expenses of the Portfolio in an amount equal to the Portfolio’s pro rata share of the AB Government Money Market Portfolio’s effective management fee. This agreement will remain in effect until September 30, 2025 and may only be terminated or changed with the consent of the Fund’s Directors. In addition, the agreement will be automatically extended for one-year terms unless the Adviser provides notice of termination to the Portfolio at least 60 days prior to the end of the period. To the extent that a Portfolio invests securities lending cash collateral in the AB Government Money Market Portfolio, the Adviser has also agreed to waive a portion of the Portfolio’s share of the advisory fees of AB Government Money Market Portfolio.
In connection with the investment by the Portfolios in the AB Government Money Market Portfolio, the Adviser waived its investment management fee from National, California, High Income, New York, Arizona, Massachusetts, Minnesota, New Jersey, Ohio, Pennsylvania and Virginia Portfolios in the amounts of $35,768, $32,357, $50,125, $7,025, $1,097, $7,371, $561, $1,668, $881, $1,067 and $3,965, respectively, for the fiscal year ended May 31, 2024, $37,550, $24,099, $32,223, $9,214, $2,316, $4,471, $1,024, $1,089, $739, $1,009 and $3,872, respectively, for the fiscal year ended May 31, 2023, and $40,393, $18,764, $61,654, $4,812, $1,615, $6,224, $1,852, $787, $1,119, $1,300 and $5,360, respectively, for the fiscal year ended May 31, 2022.
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The Adviser acts as an investment adviser to other persons, firms or corporations, including investment companies, and is the investment adviser to the following registered investment companies: AB Active ETFs, Inc., AB Bond Fund, Inc., AB Cap Fund, Inc., AB Core Opportunities Fund, Inc., AB Corporate Shares, AB Discovery Growth Fund, Inc., AB Equity Income Fund, Inc., AB Fixed-Income Shares, Inc., AB Global Bond Fund, Inc., AB Global Real Estate Investment Fund, Inc., AB Global Risk Allocation Fund, Inc., AB High Income Fund, Inc., AB Institutional Funds, Inc., AB Large Cap Growth Fund, Inc., AB Relative Value Fund, Inc., AB Sustainable Global Thematic Fund, Inc., AB Sustainable International Thematic Fund, Inc., AB Trust, AB Variable Products Series Fund, Inc., The AB Portfolios, Bernstein Fund, Inc., Sanford C. Bernstein Fund, Inc., and Sanford C. Bernstein Fund II, Inc., all registered open-end investment companies; and to AllianceBernstein Global High Income Fund, Inc., AB Multi-Manager Alternative Fund (“AMMAF”) and AllianceBernstein National Municipal Income Fund, Inc., all registered closed-end investment companies. The registered investment companies for which the Adviser serves as investment adviser are referred to collectively below as the “AB Fund Complex”, while all of these investment companies, except Bernstein Fund, Inc. and Sanford C. Bernstein Fund, Inc. (the “SCB Funds”) and AMMAF, are referred to collectively below as the “AB Funds”.
Board of Directors Information
Certain information concerning the Directors and the Advisory Board member is set forth below.
NAME, ADDRESS,* AGE AND (YEAR SERVICE BEGAN**) |
PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX OVERSEEN | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD | |||
INDEPENDENT DIRECTORS | ||||||
Garry L. Moody,# Chairman of the Board 72 (2008) |
Private Investor since prior to 2019. Formerly, Partner, Deloitte & Touche LLP (1995-2008) where he held a number of senior positions, including Vice Chairman, and U.S. and Global Investment Management Practice Managing Partner; President, Fidelity Accounting and Custody Services Company (1993-1995), where he was responsible for accounting, pricing, custody and reporting for the Fidelity mutual funds; and Partner, | 81 | None |
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NAME, ADDRESS,* AGE AND (YEAR SERVICE BEGAN**) |
PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX OVERSEEN | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD | |||
Ernst & Young LLP (1975-1993), where he served as the National Director of Mutual Fund Tax Services and Managing Partner of its Chicago Office Tax department. He served as member of the Investment Company Institute’s Board of Governors and the Independent Directors Council’s Governing Council from October 2019 through September 2023, where he also served as Chairman of its Governance Committee from October 2021 through September 2023. He is Chairman of the AB Funds and Chairman of the Independent Directors Committees since January 2023; he has served as a director or trustee since 2008, and served as Chairman of the Audit Committees of such Funds from 2008 to February 2023. | ||||||
Jorge A. Bermudez,# 73 (2020) |
Private Investor since prior to 2019. Formerly, Chief Risk Officer of Citigroup, Inc., a global financial services company, from November 2007 to March 2008; Chief Executive Officer of Citigroup’s Commercial Business Group in North America and Citibank Texas from 2005 to 2007; and a variety of other executive and leadership roles at various businesses within Citigroup prior to then; Chairman (2017-2018) | 81 | Moody’s Corporation since April 2011 |
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NAME, ADDRESS,* AGE AND (YEAR SERVICE BEGAN**) |
PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX OVERSEEN | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD | |||
of the Texas A&M Foundation Board of Trustees (Trustee 2014-2021) and Chairman of the Smart Grid Center Board at Texas A&M University since 2012; director of, among others, Citibank N.A. from 2005 to 2008, the Federal Reserve Bank of Dallas, Houston Branch from 2009 to 2011, the Federal Reserve Bank of Dallas from 2011 to 2017, and the Electric Reliability Council of Texas from 2010 to 2016; and Chair of the Audit Committee of the Board of Directors of Moody’s Corporation since December 2022. He has served as director or trustee of the AB Funds since January 2020. | ||||||
Michael J. Downey,#,^ 80 (2005)
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Private Investor since prior to 2019. Formerly, Chairman of The Asia Pacific Fund, Inc. (registered investment company) from 2002 until January 2019. From 1987 until 1993, Chairman and CEO of Prudential Mutual Fund Management, director of the Prudential mutual funds, and member of the Executive Committee of Prudential Securities Inc. He has served as a director or trustee of the AB Funds since 2005. | 81 | None |
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NAME, ADDRESS,* AGE AND (YEAR SERVICE BEGAN**) |
PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX OVERSEEN | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD | |||
Nancy P. Jacklin,#,^ 76 (2006) |
Private Investor since prior to 2019. Professorial Lecturer at the Johns Hopkins School of Advanced International Studies (2008-2015). U.S. Executive Director of the International Monetary Fund (which is responsible for ensuring the stability of the international monetary system) (December 2002-May 2006); Partner, Clifford Chance (1992-2002); Sector Counsel, International Banking and Finance, and Associate General Counsel, Citicorp (1985-1992); Assistant General Counsel (International), Federal Reserve Board of Governors (1982-1985); and Attorney Advisor, U.S. Department of the Treasury (1973-1982). Member of the Bar of the District of Columbia and of New York; and member of the Council on Foreign Relations. She has served as a director or trustee of the AB Funds since 2006 and served as Chair of the Governance and Nominating Committees of the AB Funds from 2014 until August 2023. | 81 | None | |||
Jeanette W. Loeb,# 72 (2020) |
Private Investor since prior to 2019. Director of New York City Center since 2005. Formerly, Chief Executive Officer of PetCareRx (e-commerce pet pharmacy) from 2002 to 2011 and 2015 to April | 81 | None |
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NAME, ADDRESS,* AGE AND (YEAR SERVICE BEGAN**) |
PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX OVERSEEN | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD | |||
2023. She was a director of MidCap Financial Investment Corporation (business development company) from August 2011 to July 2023 and a director of AMMAF (fund of hedge funds) from 2012 to 2018. Formerly, affiliated with Goldman Sachs Group, Inc. (financial services) from 1977 to 1994, including as a partner thereof from 1986 to 1994. She has served as director or trustee of the AB Funds since April 2020 and serves as Chair of the Governance and Nominating Committees of the AB Funds since August 2023. | ||||||
Carol C. McMullen,# 69 (2016) |
Private Investor and a member of the Advisory Board of Butcher Box (since 2018) where she also serves as Advisory Board Chair (since June 2023). Formerly, Managing Director of Slalom Consulting (consulting) from 2014 until July 2023; member, Mass General Brigham (formerly, Partners Healthcare) Investment Committee (2010-2019); Director of Norfolk & Dedham Group (mutual property and casualty insurance) from 2011 until November 2016; Director of Partners Community Physicians Organization (healthcare) from 2014 until December 2016; and Managing Director of The Crossland | 81 | None |
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NAME, ADDRESS,* AGE AND (YEAR SERVICE BEGAN**) |
PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX OVERSEEN | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD | |||
Group (consulting) from 2012 until 2013. She has held a number of senior positions in the asset and wealth management industries, including at Eastern Bank (where her roles included President of Eastern Wealth Management), Thomson Financial (Global Head of Sales for Investment Management), and Putnam Investments (where her roles included Chief Investment Officer, Core and Growth and Head of Global Investment Research). She has served on a number of private company and non-profit boards, and as a director or trustee of the AB Funds since June 2016 and serves as Chair of the Audit Committees of such Funds since February 2023. | ||||||
Marshall C. Turner, Jr.,#,^ 82 (2005) |
Private Investor since prior to 2019. He is a former (2007-2020) director of Xilinx, Inc. (programmable logic semi-conductors and adaptable, intelligent computing) and former Chairman and CEO of DuPont Photomasks, Inc. (semi-conductor manufacturing equipment) from 1999-2000 and 2003 through 2006. He has extensive operating leadership and venture capital investing experience, including five interim or full-time CEO roles, and | 81 | None |
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NAME, ADDRESS,* AGE AND (YEAR SERVICE BEGAN**) |
PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX OVERSEEN | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD | |||
prior service as general partner of institutional venture capital partnerships and as a director of a number of public and private companies. He also has extensive non-profit board leadership experience, including as a former Chair of the Corporation for Public Broadcasting and the Smithsonian’s National Museum of Natural History, and currently serves on the board of the George Lucas Educational Foundation. He served as a director of one AB Fund since 1992, and director or trustee of all the AB Funds since 2005. He has served as both Chairman of the AB Funds and Chairman of the Independent Directors Committees from 2014 through December 2022. | ||||||
INTERESTED DIRECTOR |
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Onur Erzan,+,^ 48 (2021) |
Senior Vice President of the Adviser++, Head of Global Client Group and Head of Private Wealth. He oversees AB’s entire private wealth management business and third party institutional and retail franchise, where he is responsible for all client services, sales and marketing, as well as product strategy, management and development worldwide. Director, President and | 81 | None |
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NAME, ADDRESS,* AGE AND (YEAR SERVICE BEGAN**) |
PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX OVERSEEN | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD | |||
Chief Executive Officer of the AB Mutual Funds as of April 1, 2021 and the AB ETFs as of May 5, 2022. He is also a member of the Equitable Holdings Management Committee. Prior to joining the firm in January 2021, he spent over 19 years with McKinsey (management consulting firm), most recently as a senior partner and co-leader of its Wealth & Asset Management practice. In addition, he co-led McKinsey’s Banking & Securities Solutions (a portfolio of data, analytics, and digital assets and capabilities) globally. |
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ADVISORY BOARD MEMBER |
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Emilie D. Wrapp,+ 69 (Appointed January 2024) |
Private Investor since July 2023. Former Senior Vice President, Counsel, Assistant Secretary & Senior Mutual Fund Legal Advisor of the Adviser++ (January 2023 – June 2023). Prior thereto, Senior Vice President, Assistant Secretary, Counsel, and Head of Mutual Fund & Retail Legal of the Adviser++; Assistant General Counsel and Assistant Secretary of AllianceBernstein Investments, Inc. (“ABI”) since prior to 2019 until June 2023. She has served as a member of the Advisory Board to the AB Funds since January 2024. | 81 | None |
___________________
* | The address for each of the Fund’s Directors and the Advisory Board member is c/o AllianceBernstein L.P., Attention: Legal and Compliance Department – Mutual Fund Legal, 66 Hudson Boulevard East, 26th Floor, New York, NY 10001. |
** | There is no stated term of office for the Funds’ Directors or Advisory Board member. |
# | Member of the Audit Committee, the Governance and Nominating Committee, and the Independent Directors Committee. |
+ | Mr. Erzan is an “interested person”, as defined in Section 2(a)(19) of the 1940 Act, of the Funds because of his affiliation with the Adviser. Ms. Wrapp is an “interested person”, as defined in Section 2(a)(19) of the 1940 Act, of the Funds because of her former role with the Adviser. |
++ | The Adviser is an affiliate of the Funds. |
^ | Effective December 31, 2024, Ms. Jacklin and Messrs. Downey, Erzan, and Turner will resign or retire as Directors of the Funds. |
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Changes to the Board of Directors, effective January 1, 2025. At a meeting held on July 18, 2024, shareholders of the Funds elected Directors in connection with the establishment of a single, unitary board (“Unitary Board”) responsible for overseeing mutual funds, exchange-traded funds and certain closed-end investment companies sponsored and advised by the Adviser. In connection with the establishment of the Unitary Board, Ms. Jacklin and Messrs. Downey and Turner will retire as Directors effective December 31, 2024, and Mr. Erzan will resign as a Director effective December 31, 2024, but will continue to serve as President and Chief Executive Officer of the AB Funds. Shareholders of the Funds elected four individuals, who are not current Directors, to serve as Directors effective January 1, 2025 (the “New Directors-Elect”), who will serve on the Unitary Board with current Directors Mses. Loeb and McMullen and Messrs. Bermudez and Moody (each of whom was also elected by shareholders at the July 18, 2024 meeting). Certain information concerning the New Directors-Elect is set forth below.
NAME, ADDRESS,* AGE AND (YEAR SERVICE WILL BEGIN**) | PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX TO BE OVERSEEN BY DIRECTOR | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD BY DIRECTOR-ELECT | |||
INDEPENDENT DIRECTORS | ||||||
R. Jay Gerken,^ 73 (January 2025)
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Private Investor since prior to 2019. Formerly, President and Chief Executive Officer of Legg Mason Partners Fund Advisor, LLC, and President & Board Member of The Legg Mason and Western Asset mutual funds from 2005 until June 2013. Previously, he was the President and Chair of the boards of the Citigroup Asset Management mutual funds from 2002 to 2005; Portfolio Manager and Managing Director, Smith Barney Asset Management from 1993 to 2001 and President & CEO, Directions Management of Shearson Lehman, Inc. from 1988 to 1993. He is Chair of the SCB Funds Board and the AMMAF Board since July 2023; he has served as a director or trustee of the SCB Funds since July 2013 and | 92 | Associated Banc-Corp |
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NAME, ADDRESS,* AGE AND (YEAR SERVICE WILL BEGIN**) | PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX TO BE OVERSEEN BY DIRECTOR | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD BY DIRECTOR-ELECT | |||
AMMAF since December 2018 and served as Chair of the Audit Committees of the SCB Funds from July 2018 to June 2023 and Chair of the Audit Committee of AMMAF from December 2018 to June 2023. | ||||||
Jeffrey R. Holland,^ 58 (January 2025)
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Private Investor since prior to 2019. Formerly, Limited Partner of Brown Brothers Harriman from 2014 to 2018. Prior thereto, General Partner of Brown Brothers Harriman from 2006 to 2013. He has served as a director or trustee of the SCB Funds and AMMAF since September 2019 and serves as Chair of the Audit Committees of such Funds since July 2023. | 92 | None | |||
INTERESTED DIRECTORS | ||||||
Alexander Chaloff,+, ^ 52 (January 2025) |
Senior Vice President of the Adviser++, with which he has been associated since prior to 2019. He has been Chief Investment Officer and Head of Investment & Wealth Strategies of Bernstein Private Wealth Management since April 2023. He previously served as Co-Head of the Investment Strategy Group since 2020. Prior to joining Bernstein Private Wealth Management in 2005, he was a managing director at Wilshire Associates, a leading global investment consultant, serving on the firm’s investment committee. President and Chief Executive Officer of the SCB Funds and AMMAF since April 2023. | 92 | None |
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NAME, ADDRESS,* AGE AND (YEAR SERVICE WILL BEGIN**) | PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS AND OTHER INFORMATION | PORTFOLIOS IN AB FUND COMPLEX TO BE OVERSEEN BY DIRECTOR | OTHER PUBLIC COMPANY DIRECTORSHIPS CURRENTLY HELD BY DIRECTOR-ELECT | |||
Emilie D. Wrapp,+, ^ 69 (January 2025) |
See biography above. | 92 | None | |||
___________________ |
* | The address for each of the Funds’ Directors is c/o AllianceBernstein L.P., Attention: Legal and Compliance Department – Mutual Fund Legal, 66 Hudson Boulevard East, 26th Floor, New York, NY 10001. |
** | There is no stated term of office for the Funds’ Directors. |
+ | Mr. Chaloff is an “interested person”, as defined in Section 2(a)(19) of the 1940 Act, of the Funds because of his affiliation with the Adviser. Ms. Wrapp is an “interested person”, as defined in Section 2(a)(19) of the 1940 Act, of the Funds because of her former role with the Adviser. |
++ | The Adviser is an affiliate of the Funds. |
^ | Effective January 1, 2025, Ms. Wrapp and Messrs. Chaloff, Gerken and Holland will become Directors of the Funds; and Ms. Wrapp will no longer serve as the Advisory Board member of the Funds. |
The business and affairs of the Funds are overseen by the Boards. Each Board has also established an Advisory Board, whose member assists the Boards in a non-voting capacity in its oversight of the management of the Funds. The Boards remain solely responsible for the oversight of management of the Funds. Directors who are not “interested persons” of the Funds as defined in the 1940 Act are referred to as “Independent Directors”, and Directors who are “interested persons” of the Funds are referred to as “Interested Directors”. Certain information concerning the Funds’ governance structure and each Director is set forth below.
Experience, Skills, Attributes and Qualifications of the Funds’ Directors. The Governance and Nominating Committee of each Fund’s Board, which is composed of Independent Directors, reviews the experience, qualifications, attributes and skills of potential candidates for nomination or election by the Board, and conducts a similar review in connection with the proposed nomination of current Directors for re-election by shareholders at any annual or special meeting of shareholders. In evaluating a candidate for nomination or election as a Director, the Governance and Nominating Committee considers the contribution that the candidate would be expected to make to the diverse mix of experience, qualifications, attributes and skills that the Board believes contributes to good governance for the Fund. In assessing diversity of experience, the Governance and Nominating Committee takes account of a candidate’s educational and professional background, but also the diversity of experience a candidate derives from race, gender, ethnicity, religion, nationality, disability, sexual orientation, or cultural background. Additional information concerning the Governance and Nominating Committee’s consideration of nominees appears in the description of the Committee below.
Each Board believes that, collectively, the Directors have balanced and diverse experience, qualifications, attributes and skills, which allow the Board to operate effectively in governing the Fund and protecting the interests of shareholders. Each Board has concluded that,
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based on each Director’s experience, qualifications, attributes or skills on an individual basis and in combination with those of the other Directors, each Director is qualified and should continue to serve as such.
In determining that a particular Director was and continues to be qualified to serve as a Director, each Board has considered a variety of criteria, none of which, in isolation, was controlling. In addition, each Board has taken into account the actual service and commitment of each Director during his or her tenure (including the Director’s commitment and participation in Board and committee meetings, as well as his or her current and prior leadership of standing and ad hoc committees) in concluding that each should continue to serve. Additional information about the specific experience, skills, attributes and qualifications of each Director, which in each case led to the Board’s conclusion that the Director should serve (or continue to serve) as Director of the Fund, is provided in the table above and in the next paragraph.
Among other attributes and qualifications common to all Directors are their ability to review critically, evaluate, question and discuss information provided to them (including information requested by the Directors), to interact effectively with the Adviser, other service providers, counsel and the Fund’s independent registered public accounting firm, and to exercise effective business judgment in the performance of their duties as Directors. In addition to his or her service as a Director of the Funds and other AB Funds as noted in the table above: Mr. Bermudez has extensive experience in the financial services industry, including risk management, from his service in various senior executive positions, including as Chief Risk Officer, of a large global financial services company, as a director and Audit Chair of a Federal Reserve Bank and a director of a large public company, and as Chairman or director or trustee of numerous non-profit organizations; Mr. Chaloff has business, finance and investment management experience as Head of Investment & Wealth Strategies of Bernstein Private Wealth Management of the Adviser, and he has served as President and Chief Executive Officer of the SCB Funds and AMMAF since April 2023; Mr. Downey has experience in the investment advisory business including as Chairman and Chief Executive Officer of a large fund complex and as director of a number of non-AB funds and as Chairman of a non-AB closed-end fund; Mr. Erzan has experience as an executive of the Adviser with responsibility for, among other things, the AB Funds and at a management consulting firm; Mr. Gerken has investment management experience as a portfolio manager and executive officer, and he has served as Chair of the SCB Funds Board and AMMAF Board since July 2023, has served as a director or trustee of the SCB Funds since July 2013 and AMMAF since December 2018 and served as Chair of the Audit Committees of the SCB Funds from July 2018 to June 2023 and Chair of the Audit Committee of AMMAF from December 2018 to June 2023; Mr. Holland has business experience as a senior executive of a financial services firm, including experience in provision of custody and other services to investment funds globally, and he has served as a director or trustee of the SCB Funds and AMMAF since September 2019 and serves as Chair of the Audit Committees of such Funds since July 2023; Ms. Jacklin has experience as a financial services regulator, as U.S. Executive Director of the International Monetary Fund (which is responsible for ensuring the stability of the international monetary system), as a financial services lawyer in private practice, and served as Chair of the Governance and Nominating Committees of the AB Funds from 2014 to August 2023; Ms. Loeb has extensive experience in the financial services industry and in business more generally, including as a former executive and partner of a large global financial services company and as Chief Executive Officer of a private e-commerce company, a director and audit
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committee member of a large publicly traded business development company and former director of a fund of hedge funds, and a director or trustee of numerous non-profit organizations including the United Nations Development Corporation and New York City Center and has served as Chair of the Governance and Nominating Committees of the AB Funds since August 2023; Ms. McMullen has experience in talent management for a global technology consulting firm, serves on the advisory board of a privately held e-commerce company, has served as director of a variety of privately held firms and non-profit boards (including as director of one of the 10 largest healthcare systems in the U.S. and Chair of a top U.S. community hospital), has extensive asset management industry experience including as Director of Global Investment Research for a major fund company and President of Wealth Management for a regional bank and has served as Chair of the Audit Committees of the AB Funds since February 2023; Mr. Moody, a certified public accountant, has extensive experience in the asset management industry as a senior executive of a large fund complex and as Vice Chairman and U.S. and Global Investment Management Practice Managing Partner for a major accounting firm, and served as a member of the Board of Governors of the Investment Company Institute, the leading association representing regulated funds, including mutual funds, exchange-traded funds and closed-end funds, from October 2019 through September 2023, and also the Governing Council of the Independent Directors Council, a group created by the Investment Company Institute that aims to advance the education, communication and policy positions of investment company independent directors, where he also served as the Chairman of the Governance Committee from October 2021 through September 2023, has served as a director or trustee of the AB Funds since 2008 and served as Chairman of the Audit Committees of the AB Funds from 2008 to February 2023, and has served as Chairman of the AB Funds and the Independent Directors Committees of the AB Funds since 2023; and Mr. Turner has experience as a director (including Chairman and Chief Executive Officer of a number of companies) and as a venture capital investor including prior service as general partner of three institutional venture capital partnerships, and served as both Chairman of the AB Funds and Chairman of the Independent Directors Committees from 2014 through December 2022. The disclosure herein of a director’s experience, qualifications, attributes and skills does not impose on such director any duties, obligations, or liability that are greater than the duties, obligations, and liability imposed on such director as a member of the Board and any committee thereof in the absence of such experience, qualifications, attributes and skills.
Experience, Skills, Attributes, and Qualifications of the Advisory Board Member. In addition to her service as an Advisory Board member of the Funds and other AB Funds as noted in the table above, Ms. Wrapp has extensive experience in the investment management industry, including formerly serving as Senior Vice President, Assistant Secretary, Counsel and Head of Mutual Fund & Retail Legal of the Adviser, and Assistant General Counsel and Assistant Secretary of ABI. She also served as Chief Legal Officer and Secretary of the AB Funds and other registered investment companies advised by the Adviser and had extensive involvement in fund industry organizations including committees and working groups of the Investment Company Institute. The disclosure herein of the Advisory Board member’s experience, qualifications, attributes and skills does not impose on such member any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such member as a member of the Advisory Board in the absence of such experience, qualifications, attributes and skills.
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Board Structure and Oversight Function. The Boards are responsible for oversight of the management of the Funds. Each Fund has engaged the Adviser to manage the Fund on a day-to-day basis. The Boards are responsible for overseeing the Adviser and the Funds’ other service providers in the operations of the Funds in accordance with the Funds’ investment objective and policies and otherwise in accordance with its Prospectus, the requirements of the 1940 Act and other applicable Federal, state and other securities and other laws, and each Fund’s charter and bylaws. The Boards typically meet at regularly scheduled meetings four times throughout the year. In addition, the Directors may meet at special meetings or on an informal basis at other times. The Independent Directors also regularly meet without the presence of any representatives of management. As described below, each Board has established three standing committees – the Audit, Governance and Nominating and Independent Directors Committees – and may establish ad hoc committees or working groups from time to time, to assist the Board in fulfilling its oversight responsibilities. Each committee is composed exclusively of Independent Directors. The responsibilities of each committee, including its oversight responsibilities, are described further below. The Independent Directors have also engaged independent legal counsel, and may from time to time engage consultants and other advisors, to assist them in performing their oversight responsibilities.
An Independent Director serves as Chairman of each Board. The Chairman’s duties include setting the agenda for each Board meeting in consultation with management, presiding at each Board meeting, meeting with management between Board meetings, and facilitating communication and coordination between the Independent Directors and management. The Directors have determined that the Board’s leadership by an Independent Director and its committees composed exclusively of Independent Directors is appropriate because they believe it sets the proper tone to the relationships between the Fund, on the one hand, and the Adviser and other service providers, on the other, and facilitates the exercise of the Board’s independent judgment in evaluating and managing the relationships. In addition, each Fund is required to have an Independent Director as Chairman pursuant to certain 2003 regulatory settlements involving the Adviser.
Risk Oversight. Each Fund is subject to a number of risks, including investment, compliance and operational risks, including cyber risks. Day-to-day risk management with respect to the Funds resides with the Adviser or other service providers (depending on the nature of the risk), subject to supervision by the Adviser. Each Board has charged the Adviser and its affiliates with (i) identifying events or circumstances, the occurrence of which could have demonstrable and material adverse effects on the Fund; (ii) to the extent appropriate, reasonable or practicable, implementing processes and controls reasonably designed to lessen the possibility that such events or circumstances occur or to mitigate the effects of such events or circumstances if they do occur; and (iii) creating and maintaining a system designed to evaluate continuously, and to revise as appropriate, the processes and controls described in (i) and (ii) above.
Risk oversight forms part of the Boards’ general oversight of the Funds’ investment program and operations and is addressed as part of various regular Board and committee activities. Each Fund’s investment management and business affairs are carried out by or through the Adviser and other service providers. Each of these persons has an independent interest in risk management but the policies and the methods by which one or more risk management functions are carried out may differ from the Fund’s and each other’s in the setting
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of priorities, the resources available or the effectiveness of relevant controls. Oversight of risk management is provided by the Board and the Audit Committee. The Directors regularly receive reports from, among others, management (including the Chief Risk Officer of the Adviser), the Fund’s Chief Compliance Officer, the Fund’s independent registered public accounting firm, the Adviser’s internal legal counsel, the Adviser’s Chief Compliance Officer and internal auditors for the Adviser, as appropriate, regarding risks faced by the Fund and the Adviser’s risk management programs. In addition, the Directors receive regular updates on cyber security matters from the Adviser.
Not all risks that may affect the Funds can be identified, nor can controls be developed to eliminate or mitigate their occurrence or effects. It may not be practical or cost-effective to eliminate or mitigate certain risks, the processes and controls employed to address certain risks may be limited in their effectiveness, and some risks are simply beyond the reasonable control of the Funds or the Adviser, its affiliates or other service providers. Moreover, it is necessary to bear certain risks (such as investment-related risks) to achieve the Funds’ goals. As a result of the foregoing and other factors the Funds’ ability to manage risk is subject to substantial limitations.
Board Committees. Each Fund’s Board has three standing committees of the Board – an Audit Committee, a Governance and Nominating Committee and an Independent Directors Committee. The members of the Audit, Governance and Nominating and Independent Directors Committees are identified above.
The function of the Audit Committee is to assist the Boards in their oversight of the Funds’ accounting and financial reporting policies and practices. The Audit Committee met three times each during each Fund’s most recently completed fiscal year.
The function of the Governance and Nominating Committee includes the nomination of persons to fill any vacancies or newly created positions on the Boards. The Governance and Nominating Committee met three times each during each Fund’s most recently completed fiscal year.
Each Fund’s Board has adopted a charter for its Governance and Nominating Committee. Pursuant to the charter, the Committee assists each Board in carrying out its responsibilities with respect to governance of a Fund and identifies, evaluates, selects and nominates candidates for the Board. The Committee may also set standards or qualifications for Directors and reviews at least annually the performance of each Director, taking into account factors such as attendance at meetings, adherence to Board policies, preparation for and participation at meetings, commitment and contribution to the overall work of the Board and its committees, and whether there are health or other reasons that might affect the Director’s ability to perform his or her duties. The Committee may consider candidates for nomination as Directors submitted by a Fund’s current Board members, officers, the Adviser, shareholders and other appropriate sources.
Pursuant to the charter, the Governance and Nominating Committee will consider candidates for nomination as a director submitted by a shareholder or group of shareholders who have beneficially owned at least 5% of a Portfolio’s common stock or shares of beneficial interest for at least two years prior to the time of submission and who timely provide specified information
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about the candidates and the nominating shareholder or group. To be timely for consideration by the Governance and Nominating Committee, the submission, including all required information, must be submitted in writing to the attention of the Secretary at the principal executive offices of the Funds not less than 120 days before the date of the proxy statement for the previous year’s annual meeting of shareholders. If the Funds did not hold an annual meeting of shareholders in the previous year, the submission must be delivered or mailed and received within a reasonable amount of time before the Funds begin to print and mail their proxy materials. Public notice of such upcoming annual meeting of shareholders may be given in a shareholder report or other mailing to shareholders or by other means deemed by the Governance and Nominating Committee or the Board to be reasonably calculated to inform shareholders.
Shareholders submitting a candidate for consideration by the Governance and Nominating Committee must provide the following information to the Governance and Nominating Committee: (i) a statement in writing setting forth (A) the name, date of birth, business address and residence address of the candidate; (B) any position or business relationship of the candidate, currently or within the preceding five years, with the shareholder or an associated person of the shareholder as defined below; (C) the class or series and number of all shares of a Portfolio owned of record or beneficially by the candidate; (D) any other information regarding the candidate that is required to be disclosed about a nominee in a proxy statement or other filing required to be made in connection with the solicitation of proxies for election of Directors pursuant to Section 20 of the 1940 Act and the rules and regulations promulgated thereunder; (E) whether the shareholder believes that the candidate is or will be an “interested person” of the Funds (as defined in the 1940 Act) and, if believed not to be an “interested person,” information regarding the candidate that will be sufficient for the Funds to make such determination; and (F) information as to the candidate’s knowledge of the investment company industry, experience as a director or senior officer of public companies, directorships on the boards of other registered investment companies and educational background; (ii) the written and signed consent of the candidate to be named as a nominee and to serve as a Director if elected; (iii) the written and signed agreement of the candidate to complete a directors’ and officers’ questionnaire if elected; (iv) the shareholder’s consent to be named as such by the Funds; (v) the class or series and number of all shares of a Portfolio of the Funds owned beneficially and of record by the shareholder and any associated person of the shareholder and the dates on which such shares were acquired, specifying the number of shares owned beneficially but not of record by each, and stating the names of each as they appear on the Funds’ record books and the names of any nominee holders for each; and (vi) a description of all arrangements or understandings between the shareholder, the candidate and/or any other person or persons (including their names) pursuant to which the recommendation is being made by the shareholder. “Associated Person of the shareholder” means any person who is required to be identified under clause (vi) of this paragraph and any other person controlling, controlled by or under common control with, directly or indirectly, (a) the shareholder or (b) the associated person of the shareholder.
The Governance and Nominating Committee may require the shareholder to furnish such other information as it may reasonably require or deem necessary to verify any information furnished pursuant to the nominating procedures described above or to determine the qualifications and eligibility of the candidate proposed by the shareholder to serve on the Board. If the shareholder fails to provide such other information in writing within seven days of receipt of written request from the Governance and Nominating Committee, the recommendation of such candidate as a nominee will be deemed not properly submitted for consideration, and will
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not be considered, by the Committee.
The Governance and Nominating Committee will consider only one candidate submitted by such a shareholder or group for nomination for election at an annual meeting of shareholders. The Governance and Nominating Committee will not consider self-nominated candidates. The Governance and Nominating Committee will consider and evaluate candidates submitted by shareholders on the basis of the same criteria as those used to consider and evaluate candidates submitted from other sources. These criteria include the candidate’s relevant knowledge, experience, and expertise, the candidate’s ability to carry out his or her duties in the best interests of the Funds and the candidate’s ability to qualify as an Independent Director or Trustee. When assessing a candidate for nomination, the Committee considers whether the individual’s background, skills, and experience will complement the background, skills, and experience of other nominees and will contribute to the diversity of the Board.
The function of the Independent Directors Committee is to consider and take action on matters that the Board or Committee believes should be addressed in executive session of the Independent Directors, such as review and approval of the Advisory and Distribution Services Agreements. The Independent Directors Committee met nine times during each Fund’s most recently completed fiscal year.
The dollar range of each Portfolio’s securities owned by each Director and the aggregate dollar range of securities of funds in the AB Fund Complex owned by each Director are set forth below.
Dollar Range of Equity Securities in the Portfolios | ||||
As of December 31, 2023 | ||||
NATIONAL PORTFOLIO |
HIGH INCOME PORTFOLIO |
NEW YORK PORTFOLIO |
CALIFORNIA PORTFOLIO | |
Jorge A. Bermudez | None | None | None | None |
Michael J. Downey | None | None | None | None |
Onur Erzan | None | None | None | None |
Nancy P. Jacklin | $50,001-$100,000 | None | None | None |
Jeanette W. Loeb | None | None | $10,001-$50,000 | None |
Carol C. McMullen | None | None | None | None |
Garry L. Moody | None | None | None | None |
Marshall C. Turner, Jr. | None | None | None | None |
Advisory Board Member | ||||
Emilie D. Wrapp^ | None | None | None | None |
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ARIZONA PORTFOLIO |
MASSACHUSETTS PORTFOLIO |
MINNESOTA PORTFOLIO | |
Jorge A. Bermudez | None | None | None |
Michael J. Downey | None | None | None |
Onur Erzan | None | None | None |
Nancy P. Jacklin | None | None | None |
Jeanette W. Loeb | None | None | None |
Carol C. McMullen | None | None | None |
Garry L. Moody | None | None | None |
Marshall C. Turner, Jr. | None | None | None |
Advisory Board Member | |||
Emilie D. Wrapp^ | None | None | None |
NEW JERSEY PORTFOLIO |
OHIO PORTFOLIO |
PENNSYLVANIA PORTFOLIO |
VIRGINIA PORTFOLIO | |
Jorge A. Bermudez | None | None | None | None |
Michael J. Downey | None | None | None | None |
Onur Erzan | None | None | None | None |
Nancy P. Jacklin | None | None | None | None |
Jeanette W. Loeb | None | None | None | None |
Carol C. McMullen | None | None | None | None |
Garry L. Moody | None | None | None | None |
Marshall C. Turner, Jr. | None | None | None | None |
Advisory Board Member | ||||
Emilie D. Wrapp^ | None | None | None | None |
AGGREGATE DOLLAR RANGE OF EQUITY SECURITIES IN THE AB FUND COMPLEX AS OF DECEMBER 31, 2023 | |
Jorge A. Bermudez | Over $100,000 |
Michael J. Downey | Over $100,000 |
Onur Erzan | Over $100,000 |
Nancy P. Jacklin | Over $100,000 |
Jeanette W. Loeb | Over $100,000 |
Carol C. McMullen | Over $100,000 |
Garry L. Moody | Over $100,000 |
Marshall C. Turner, Jr. | Over $100,000 |
Advisory Board Member |
|
Emilie D. Wrapp^ | None |
___________________
^ | Ms. Wrapp was appointed as an Advisory Board member of the Funds effective January 1, 2024. |
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Officer Information
Certain information concerning each Fund’s officers is set forth below.
NAME, ADDRESS* AND AGE |
POSITION(S) HELD WITH FUND |
PRINCIPAL OCCUPATION DURING PAST 5 YEARS | ||
Onur Erzan, 48 |
President and Chief Executive Officer |
See biography above.
| ||
Daryl Clements, 57 |
Vice President | Senior Vice President of the Adviser**, with which he has been associated since prior to 2019. | ||
Matthew J. Norton, 41 |
Vice President | Senior Vice President of the Adviser**, with which he has been associated since prior to 2019. He is also Chief Investment Officer of Municipal Bonds. | ||
Andrew D. Potter, 39 |
Vice President | Vice President of the Adviser**, with which he has been associated since prior to 2019. | ||
Nancy E. Hay, 52 |
Secretary | Senior Vice President and Counsel of the Adviser**, with which she has been associated since prior to 2019 and Assistant Secretary of ABI**. | ||
Michael B. Reyes, 48 |
Senior Vice President | Senior Vice President of the Adviser**, with which he has been associated since prior to 2019. | ||
Stephen M. Woetzel, 52 |
Treasurer and Chief Financial Officer | Senior Vice President of ABIS**, with which he has been associated since prior to 2019. | ||
Phyllis J. Clarke, 63 |
Controller | Vice President of ABIS**, with which she has been associated since prior to 2019. | ||
Jennifer Friedland, 50 |
Chief Compliance Officer | Vice President of the Adviser** since 2020 and Mutual Fund Chief Compliance Officer (of all Funds since January 2023 and of the ETF Funds since 2022). Before joining the Adviser** in 2020, she was Chief Compliance Officer at WestEnd Advisors, LLC from 2013 until 2019. |
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NAME, ADDRESS* AND AGE |
POSITION(S) HELD WITH FUND |
PRINCIPAL OCCUPATION DURING PAST 5 YEARS | ||
Officer at WestEnd Advisors, LLC from 2013 until 2019. |
___________________
* | The address for each of the Funds’ officers is 66 Hudson Boulevard East, 26th Floor, New York, NY 10001. |
** | The Adviser, ABI and ABIS are affiliates of the Funds. |
The Funds do not pay any fees to, or reimburse expenses of, their Directors who are considered “interested persons” (as defined in Section 2(a)(19) of the 1940 Act) of a Portfolio, except that the Funds will pay fees to, and reimburse expenses of, Ms. Wrapp commencing in 2025. The aggregate compensation paid to each of the Directors by the Portfolios during their fiscal years ended May 31, 2024, the aggregate compensation paid to each of the Directors during calendar year 2023 by the AB Fund Complex and the total number of registered investment companies (and separate investment portfolios within those companies) in the AB Fund Complex with respect to which each of the Directors serves as a director or trustee, are set forth below. Neither the Funds nor any other fund in the AB Fund Complex provides compensation in the form of pension or retirement benefits to any of its directors or trustees. Each of the Directors is a director or trustee of one or more other registered investment companies in the AB Fund Complex.
Name of
Director of the Fund |
Aggregate Compensation from the Fund |
Aggregate Compensation from the Fund II | ||||||
Jorge A. Bermudez | $ | 18,715 | $ | 16,803 | ||||
Michael J. Downey | $ | 18,715 | $ | 16,803 | ||||
Onur Erzan | $ | 0 | $ | 0 | ||||
Nancy P. Jacklin | $ | 18,944 | $ | 17,011 | ||||
Jeanette W. Loeb | $ | 21,292 | $ | 19,116 | ||||
Carol C. McMullen | $ | 22,457 | $ | 20,164 | ||||
Garry L. Moody | $ | 27,136 | $ | 24,365 | ||||
Marshall C. Turner, Jr. | $ | 18,715 | $ | 16,803 | ||||
Name of Advisory Board Member |
||||||||
Emilie D. Wrapp^ | $ | 9,706 | $ | 8,725 |
Name of Director of the Fund | Total Compensation from the AB Fund Complex, including the Funds | Total Number of Investment Companies in the AB Fund Complex, including the Fund, as to which the Director is a Director or Trustee | Total Number of Investment Portfolios within the AB Fund Complex, including the Fund, as to which the Director is a Director or Trustee | |||||||||
Jorge A. Bermudez | $ | 330,000 | 28 | 81 | ||||||||
Michael J. Downey | $ | 330,000 | 28 | 81 | ||||||||
Onur Erzan | $ | 0 | 28 | 81 | ||||||||
Nancy P. Jacklin | $ | 358,875 | 28 | 81 | ||||||||
Jeanette W. Loeb | $ | 350,625 | 28 | 81 |
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Carol C. McMullen | $ | 379,500 | 28 | 81 | ||||||||
Garry L. Moody | $ | 478,500 | 28 | 81 | ||||||||
Marshall C. Turner, Jr. | $ | 330,000 | 28 | 81 | ||||||||
Name of Advisory Board Member |
||||||||||||
Emilie D. Wrapp^ | $ | 0 | 28 | 81 |
________________
^ | As Ms. Wrapp was appointed as an Advisory Board member of the AB Funds effective January 1, 2024, she did not receive compensation during calendar year 2023. Effective January 1, 2024, she receives the same compensation as the Directors of the Funds who are not “interested persons” of the Funds. |
As of September 3, 2024, the Directors and officers of each of the Funds, as a group owned less than 1% of the shares of each Portfolio.
Additional Information About the Portfolios’ Portfolio Managers
The management of, and investment decisions for, the Portfolios’ portfolios are made by the Municipal Bond Investment Team. The investment professionals1 with the most significant responsibility for the day-to-day management of the Portfolios’ portfolios are: Daryl Clements, Matthew J. Norton and Andrew D. Potter. For additional information about the portfolio management of each Portfolio, see “Management of the Portfolios – Portfolio Managers” in the Funds’ Prospectus.
The dollar ranges2 of the Portfolios’ equity securities owned directly or beneficially by the Portfolios’ portfolio managers as of May 31, 2024 for the High Income Portfolio and the New York Portfolio are set forth below. The Portfolios’ portfolio managers did not directly or beneficially own equity securities in any of the other Portfolios as of May 31, 2024.
HIGH INCOME PORTFOLIO | |
Daryl Clements | $50,001 - $100,000 |
Matthew J. Norton | $10,001 - $50,000 |
Andrew D. Potter | $10,001 - $50,000 |
NEW YORK PORTFOLIO | |
Daryl Clements | None |
Matthew J. Norton | $10,001 - $50,000 |
Andrew D. Potter | None |
________________________
1 | Investment professionals at the Adviser include portfolio managers and research analysts. Investment professionals are part of investment groups (or teams) that service individual fund portfolios. The number of investment professionals assigned to a particular fund will vary from fund to fund. |
2 | The ranges presented include any vested shares awarded under the Adviser's Partners Compensation Plan (the “Plan”). |
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As of May 31, 2024, employees of the Adviser had approximately $24,862,628 invested in shares of all AB Mutual Funds (excluding AB money market funds) through their interests in certain deferred compensation plans, including the Partners Compensation Plan, including both vested and unvested amounts.
The following tables provide information regarding registered investment companies (other than the Portfolios), other pooled investment vehicles and other accounts over which the Portfolios’ portfolio managers also have day-to-day management responsibilities. The tables provide the numbers of such accounts, the total assets in such accounts and the number of accounts and total assets whose fees are based on performance. The information is provided as of May 31, 2024 with regard to all Portfolios.
- National Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $20,194,000,000 | None | None |
Matthew J. Norton | 26 | $20,194,000,000 | None | None |
Andrew D. Potter | 26 | $20,194,000,000 | None | None |
- High Income Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $19,252,000,000 | None | None |
Matthew J. Norton | 26 | $19,252,000,000 | None | None |
Andrew D. Potter | 26 | $19,252,000,000 | None | None |
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- California Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $20,884,000,000 | None | None |
Matthew J. Norton | 26 | $20,884,000,000 | None | None |
Andrew D. Potter | 26 | $20,884,000,000 | None | None |
- New York Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $21,548,000,000 | None | None |
Matthew J. Norton | 26 | $21,548,000,000 | None | None |
Andrew D. Potter | 26 | $21,548,000,000 | None | None |
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- High Income, California, New York and National Portfolios
OTHER POOLED INVESTMENT VEHICLES | ||||
Portfolio Manager | Total Number of Other Pooled Investment Vehicles Managed | Total Assets of Other Pooled Investment Vehicles Managed | Number of Other Pooled Investment Vehicles Managed with Performance-based Fees | Total Assets of Other Pooled Investment Vehicles Managed with Performance-based Fees |
Daryl Clements | 13 | $8,648,000,000 | None | None |
Matthew J. Norton | 13 | $8,648,000,000 | None | None |
Andrew D. Potter | 13 | $8,648,000,000 | None | None |
- High Income, California, New York and National Portfolios
OTHER ACCOUNTS3 | ||||
Portfolio Manager | Total Number of Other Accounts Managed | Total Assets of Other Accounts Managed | Number of Other Accounts Managed with Performance-based Fees | Total Assets of Other Accounts Managed with Performance-based Fees |
Daryl Clements | 12,216 | $34,185,000,000 | 2 | $117,000,000 |
Matthew J. Norton | 12,216 | $34,185,000,000 | 2 | $117,000,000 |
Andrew D. Potter | 12,216 | $34,185,000,000 | 2 | $117,000,000 |
________________________
3 | Each investment vehicle or account represented in the chart, for which the investment professionals have portfolio management responsibility, is based upon one of nine model portfolios. Each vehicle or account differs from its respective model portfolio only to a limited extent based on specific client requirements relating to the client’s tax considerations, cash flows due to the frequency and amount of investments, and/or client-imposed investment restrictions regarding particular types of industries. |
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- Arizona Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $21,959,000,000 | None | None |
Matthew J. Norton | 26 | $21,959,000,000 | None | None |
Andrew D. Potter | 26 | $21,959,000,000 | None | None |
- Massachusetts Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $21,807,000,000 | None | None |
Matthew J. Norton | 26 | $21,807,000,000 | None | None |
Andrew D. Potter | 26 | $21,807,000,000 | None | None |
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- Minnesota Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $22,008,000,000 | None | None |
Matthew J. Norton | 26 | $22,008,000,000 | None | None |
Andrew D. Potter | 26 | $22,008,000,000 | None | None |
- New Jersey Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $21,976,000,000 | None | None |
Matthew J. Norton | 26 | $21,976,000,000 | None | None |
Andrew D. Potter | 26 | $21,976,000,000 | None | None |
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- Ohio Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $21,995,000,000 | None | None |
Matthew J. Norton | 26 | $21,995,000,000 | None | None |
Andrew D. Potter | 26 | $21,995,000,000 | None | None |
- Pennsylvania Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $21,992,000,000 | None | None |
Matthew J. Norton | 26 | $21,992,000,000 | None | None |
Andrew D. Potter | 26 | $21,992,000,000 | None | None |
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- Virginia Portfolio
REGISTERED INVESTMENT COMPANIES (excluding the Portfolio) | ||||
Portfolio Manager | Total Number of Registered Investment Companies Managed | Total Assets of Registered Investment Companies Managed | Number of Registered Investment Companies Managed with Performance-based Fees | Total Assets of Registered Investment Companies Managed with Performance-based Fees |
Daryl Clements | 26 | $21,848,000,000 | None | None |
Matthew J. Norton | 26 | $21,848,000,000 | None | None |
Andrew D. Potter | 26 | $21,848,000,000 | None | None |
- All Portfolios of Fund II
OTHER POOLED INVESTMENT VEHICLES | ||||
Portfolio Manager | Total Number of Other Pooled Investment Vehicles Managed | Total Assets of Other Pooled Investment Vehicles Managed | Number of Other Pooled Investment Vehicles Managed with Performance-based Fees | Total Assets of Other Pooled Investment Vehicles Managed with Performance-based Fees |
Daryl Clements | 13 | $8,648,000,000 | None | None |
Matthew J. Norton | 13 | $8,648,000,000 | None | None |
Andrew D. Potter | 13 | $8,648,000,000 | None | None |
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- All Portfolios of Fund II
OTHER ACCOUNTS4 | ||||
Portfolio Manager | Total Number of Other Accounts Managed | Total Assets of Other Accounts Managed | Number of Other Accounts Managed with Performance-based Fees | Total Assets of Other Accounts Managed with Performance-based Fees |
Daryl Clements | 12,216 | $34,185,000,000 | 2 | $117,000,000 |
Matthew J. Norton | 12,216 | $34,185,000,000 | 2 | $117,000,000 |
Andrew D. Potter | 12,216 | $34,185,000,000 | 2 | $117,000,000 |
Investment Professional Conflict of Interest Disclosure
As an investment adviser and fiduciary, the Adviser owes its clients and shareholders an undivided duty of loyalty. The Adviser recognizes that conflicts of interest are inherent in its business and accordingly has developed policies and procedures (including oversight monitoring) reasonably designed to detect, manage and mitigate the effects of actual or potential conflicts of interest in the area of employee personal trading, managing multiple accounts for multiple clients, including AB Mutual Funds, and allocating investment opportunities. Investment professionals, including portfolio managers and research analysts, are subject to the above-mentioned policies and oversight monitoring to ensure that all clients are treated equitably. The Adviser places the interests of its clients first and expects all of its employees to meet their fiduciary duties.
Employee Personal Trading. The Adviser has adopted a Code of Business Conduct and Ethics that is designed to detect and prevent conflicts of interest when investment professionals and other personnel of the Adviser own, buy or sell securities which may be owned by, or bought or sold for, clients. Personal securities transactions by an employee may raise a potential conflict of interest when an employee owns or trades in a security that is owned or considered for purchase or sale by a client, or recommended for purchase or sale by an employee to a client. Subject to the reporting requirements and other limitations of its Code of Business Conduct and Ethics, the Adviser permits its employees to engage in personal securities transactions, and also allows them to acquire investments in certain funds managed by the Adviser. The Adviser’s Code of Business Conduct and Ethics requires disclosure of all personal accounts and maintenance of brokerage accounts with designated broker-dealers approved by the Adviser. The Code of Business Conduct and Ethics also requires preclearance of all securities
________________________
4 | Each investment vehicle or account represented in the chart, for which the investment professionals have portfolio management responsibility, is based upon one of nine model portfolios. Each vehicle or account differs from its respective model portfolio only to a limited extent based on specific client requirements relating to the client’s tax considerations, cash flows due to the frequency and amount of investments, and/or client-imposed investment restrictions regarding particular types of industries. |
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transactions (except transactions in U.S. Treasuries and open-end mutual funds other than funds advised by the Adviser) and imposes a 60-day holding period for securities purchased by employees to discourage short-term trading.
Managing Multiple Accounts for Multiple Clients. The Adviser has compliance policies and oversight monitoring in place to address conflicts of interest relating to the management of multiple accounts for multiple clients. Conflicts of interest may arise when an investment professional has responsibilities for the investments of more than one account because the investment professional may be unable to devote equal time and attention to each account. The investment professional or investment professional teams for each client may have responsibilities for managing all or a portion of the investments of multiple accounts with a common investment strategy, including other registered investment companies, unregistered investment vehicles, such as hedge funds, pension plans, separate accounts, collective trusts and charitable foundations. Among other things, the Adviser’s policies and procedures provide for the prompt dissemination to investment professionals of initial or changed investment recommendations by analysts so that investment professionals are better able to develop investment strategies for all accounts they manage. In addition, investment decisions by investment professionals are reviewed for the purpose of maintaining uniformity among similar accounts and ensuring that accounts are treated equitably. Investment professional compensation reflects a broad contribution in multiple dimensions to long-term investment success for clients of the Adviser and is generally not tied specifically to the performance of any particular client’s account, nor is it generally tied directly to the level or change in level of assets under management.
Allocating Investment Opportunities and Order Aggregation. The investment professionals at the Adviser routinely are required to select and allocate investment opportunities among accounts. The Adviser has adopted policies and procedures intended to address conflicts of interest relating to the allocation of investment opportunities. These policies and procedures are designed to ensure that information relevant to investment decisions is disseminated promptly within its portfolio management teams and investment opportunities are allocated equitably among different clients, subject to the exceptions noted below. The policies and procedures require, among other things, objective allocation for limited investment opportunities (e.g., on a rotational basis), and documentation and review of justifications for any decisions to make investments only for select accounts or in a manner disproportionate to the size of the account. Portfolio holdings, position sizes, and industry and sector exposures tend to be similar across similar accounts, which minimizes the potential for conflicts of interest relating to the allocation of investment opportunities. Nevertheless, access to portfolio funds or other investment opportunities (including IPOs) may be allocated differently among accounts due to the particular characteristics of an account, such as size of the account, cash position, tax status, risk tolerance and investment restrictions or for other reasons. Additional information about the Adviser’s policy relating to the allocation of investment opportunities may be found in the Adviser’s Form ADV, which is updated from time to time.
Generally, all orders in the same security are aggregated in each trading system by the Adviser to facilitate best execution and to reduce overall trading costs. Executions for aggregated orders with the same executing broker are combined to determine one average price. The securities are then allocated to participating accounts using automated algorithms designed
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to achieve a fair, equitable and objective distribution of the securities over time. When the liquidity in a market is not sufficient to fill all client orders, the Adviser may give priority to certain orders over others. This prioritization is based on objective factors driving the order. Under such circumstances, the Adviser aggregates orders by these factors and subjects each aggregated order to the trade allocation algorithms discussed above. The factors used, in order of priority, are (1) correction of guideline breaches; (2) avoidance of guideline breaches; (3) investing significant new funding and completing tax strategy implementations; (4) investing in services that focus on specific financial instruments or market sectors, (5) avoidance of tracking error on the service/product level; and (6) portfolio rebalancing and optimization. Separate orders with the same priority may be traded using a rotational process that is fair and objective.
The Adviser may not require orders in the same security from different managers to be aggregated where one manager’s investment strategy requires rapid trade execution, provided the Adviser believes that disaggregation will not materially impact other client orders. Certain other clients of the Adviser have investment objectives and policies similar to those of the Portfolios. The Adviser may, from time to time, make recommendations that result in the purchase or sale of a particular security by its other clients simultaneously with a purchase or sale thereof by one or more Portfolios. If transactions on behalf of more than one client during the same period increase the demand for securities being purchased or the supply of securities being sold, there may be an adverse effect on price or the quantity of securities available at a particular price. It is the policy of the Adviser to allocate advisory recommendations and the placing of orders in a manner that is deemed equitable by the Adviser to the accounts involved, including the Portfolios. When two or more of the clients of the Adviser (including a Portfolio) are purchasing or selling the same security on a given day through the same broker or dealer, such transactions are averaged as to price. The securities are then allocated to participating accounts using automated algorithms designed to achieve a fair, equitable and objective distribution of the securities over time.
The Adviser’s procedures are also designed to address potential conflicts of interest that may arise when the Adviser has a particular financial incentive, such as a performance-based management fee, relating to an account. The Adviser is conscious of these potential conflicts. When the Adviser is providing fiduciary services, the goal of the Adviser’s policies and procedures is to act in good faith and to treat all client accounts in a fair and equitable manner over time, regardless of their strategy, fee arrangements or the influence of their owners or beneficiaries.
Portfolio Manager Compensation
The Adviser’s compensation program for portfolio managers is designed to align with clients’ interests, emphasizing each portfolio manager’s ability to generate long-term investment success for the Adviser’s clients, including the Portfolios. The Adviser also strives to ensure that compensation is competitive and effective in attracting and retaining the highest caliber employees.
Portfolio managers receive a base salary, incentive compensation and contributions to AllianceBernstein’s 401(k) plan. Part of the annual incentive compensation is generally paid in the form of a cash bonus, and part through an award under the firm’s Incentive
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Compensation Award Plan (ICAP). The ICAP awards vest over a three-year period. Deferred awards are paid in the form of restricted grants of the firm’s Master Limited Partnership Units, and award recipients have the ability to receive a portion of their awards in deferred cash. The amount of contributions to the 401(k) plan is determined at the sole discretion of the Adviser. On an annual basis, the Adviser endeavors to combine all of the foregoing elements into a total compensation package that considers industry compensation trends and is designed to retain its best talent.
The incentive portion of total compensation is determined by quantitative and qualitative factors. Quantitative factors, which are weighted more heavily, are driven by investment performance. Qualitative factors are driven by contributions to the investment process and client success.
The quantitative component includes measures of absolute, relative and risk-adjusted investment performance. Relative and risk-adjusted returns are determined based on the benchmark in the Portfolios’ Prospectus and versus peers over one-, three- and five-year calendar periods, with more weight given to longer-time periods. Peer groups are chosen by Chief Investment Officers, who consult with the product management team to identify products most similar to our investment style and most relevant within the asset class. Portfolio managers of the Portfolios do not receive any direct compensation based upon the investment returns of any individual client account, and compensation is not tied directly to the level or change in level of assets under management.
Among the qualitative components considered, the most important include thought leadership, collaboration with other investment colleagues, contributions to risk-adjusted returns of other portfolios in the firm, efforts in mentoring and building a strong talent pool and being a good corporate citizen. Other factors can play a role in determining portfolio managers’ compensation, such as the complexity of investment strategies managed, volume of assets managed and experience.
The Adviser emphasizes four behavioral competencies—relentlessness, ingenuity, team orientation and accountability—that support its mission to be the most trusted advisor to its clients. Assessments of investment professionals are formalized in a year-end review process that includes 360-degree feedback from other professionals from across the investment teams and the Adviser.
EXPENSES OF THE FUNDS
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Distribution Services Agreements
Each Fund has entered into a Distribution Services Agreement (“Agreement”) with ABI, the Funds’ principal underwriter, to permit ABI to distribute the Portfolios’ shares and to permit the Portfolio to pay distribution services fees to defray expenses associated with the distribution of the Portfolios’ Class A, Class C and Class 1 shares, as applicable, in accordance
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with a plan of distribution that is included in the Agreement and that has been duly adopted and approved in accordance with Rule 12b-1 adopted by the SEC under the 1940 Act (each a “Rule 12b-1 Plan”).
In approving the Rule 12b-1 Plan, the Directors determined that there was a reasonable likelihood that the Rule 12b-1 Plan would benefit the Funds and their shareholders. The distribution services fee of a particular class will not be used to subsidize the provision of distribution services with respect to any other class.
The Adviser from time to time and from its own funds or such other resources as may be permitted by rules of the SEC makes payments for distribution services to ABI; the latter may in turn pay part or all of such compensation to brokers or other persons for their distribution assistance.
The Rule 12b-1 Plan continues in effect with respect to each class of a Portfolio so long as such continuance is specifically approved at least annually by the Directors and by a majority of the Directors who are not parties to the Agreements or “interested persons,” as defined in the 1940 Act, of any such party (other than as Directors or Trustees of the Funds) and who have no direct or indirect financial interest in the operation of the Rule 12b-1 Plan or any agreement related thereto (“Qualified Directors”). Most recently, continuance of the Agreements was approved for an additional annual term by a vote of the Directors, including a majority of Qualified Directors at their meetings held on July 30-31, 2024.
All material amendments to the Rule 12b-1 Plan will become effective only upon approval as provided in the preceding paragraph, and the 12b-1 Plan may not be amended in order to materially increase the costs that the Portfolios may bear pursuant to the Agreement without the approval of a majority of the holders of the outstanding voting shares of a Portfolio or the class or classes of the Portfolio affected. The Agreement may be terminated (a) by the Portfolio without penalty at any time by a majority vote of the holders of the Portfolio’s outstanding voting securities, voting separately by class, or by a majority vote of the Qualified Directors or (b) by ABI. To terminate the Rule 12b-1 Plan or Agreement, any party must give the other parties 60 days’ written notice except that a Portfolio may terminate the Rule 12b-1 Plan without giving prior notice to ABI. The Agreement will terminate automatically in the event of its assignment. The Rule 12b-1 Plan is of a type known as a “reimbursement plan”, which means that it reimburses the distributor for the actual costs of services rendered.
In the event that the Rule 12b-1 Plan is terminated by either party or not continued with respect to the Class A, Class C or Class 1 shares, (i) no distribution services fees (other than current amounts accrued but not yet paid) would be owed by the Portfolio to ABI with respect to that class and (ii) the Portfolio would not be obligated to pay ABI for any amounts expended under the Agreement not previously recovered by ABI from distribution services fees in respect of shares of such class or through deferred sales charges.
Distribution services fees are accrued daily and paid monthly and are charged as expenses of the Portfolio as accrued. The distribution services fees attributable to the Class C shares and Class 1 shares are designed to permit an investor to purchase such shares through broker-dealers without the assessment of an initial sales charge, and at the same time to permit
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ABI to compensate broker-dealers in connection with the sale of such shares. In this regard the purpose and function of the combined contingent deferred sales charges (“CDSCs”) and distribution services fees on the Class C and Class 1 shares, are the same as those of the initial sales charge and distribution services fee with respect to the Class A shares in that the sales charge and distribution services fee provide for the financing of the distribution of the relevant class of the Portfolio’s shares.
With respect to Class A shares of the Funds, distribution expenses accrued by ABI in one fiscal year may not be paid from distribution services fees received from the Funds in subsequent fiscal years. ABI’s compensation with respect to Class C and Class 1 shares under the Rule 12b-1 Plan is directly tied to the expenses incurred by ABI. Actual distribution expenses for Class C and Class 1 shares for any given year, however, will probably exceed the distribution services fee payable under each Rule 12b-1 Plan with respect to the class involved and, in the case of Class C shares, payments received from CDSCs. The excess will be carried forward by ABI and reimbursed from distribution services fees payable under the Rule 12b-1 Plan with respect to the class involved and, in the case of Class C shares, payments subsequently received through CDSCs, so long as each Rule 12b-1 Plan is in effect.
Pursuant to the Plan, each class of each Portfolio pays ABI a Rule 12b-1 distribution services fee which may not exceed an annual rate of 0.30% of a Portfolio’s aggregate average daily net assets attributable to the Class A shares and 1.00% of a Portfolio’s aggregate average daily net assets attributable to the Class C shares to compensate ABI for distribution expenses. For Class A shares, the Board currently limits the distribution services fee to 0.25%. The Plan provides that a portion of the distribution services fee in an amount not to exceed 0.25% of the aggregate daily net assets of a Portfolio attributable to each of the Class A and Class C shares constitutes a service fee that ABI will use for personal services and/or the maintenance of shareholder accounts.
During the fiscal year ended May 31, 2024, with respect to Class A shares, the distribution services fees for expenditures payable to ABI were as follows:
Portfolio | Distribution Services Fees for Expenditures Payable to ABI | Percentage Per Annum of the Aggregate Average Daily Net Assets Attributable to Class A Shares | ||||||
National | $ | 1,039,163 | 0.25 | % | ||||
High Income | $ | 1,441,348 | 0.25 | % | ||||
New York | $ | 809,374 | 0.25 | % | ||||
California | $ | 1,162,205 | 0.25 | % | ||||
Arizona | $ | 175,333 | 0.25 | % | ||||
Massachusetts | $ | 205,207 | 0.25 | % | ||||
Minnesota | $ | 78,645 | 0.25 | % | ||||
New Jersey | $ | 152,214 | 0.25 | % | ||||
Ohio | $ | 115,357 | 0.25 | % | ||||
Pennsylvania | $ | 120,958 | 0.25 | % | ||||
Virginia | $ | 275,681 | 0.25 | % |
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Expenses incurred by each Portfolio and costs allocated to each Portfolio in connection with activities primarily intended to result in the sale of Class A shares were as follows:
Category of Expense |
National Portfolio |
High Income Portfolio |
New York Portfolio |
California Portfolio |
Arizona Portfolio |
Massachusetts Portfolio |
Advertising/Marketing | $14,920 | $20,353 | $11,588 | $16,646 | $2,517 | $2,946 |
Printing and Mailing of Prospectuses and Semi-Annual and Annual Reports to Other Than Current Shareholders | $2,128 | $2,857 | $1,633 | $2,380 | $353 | $415 |
Compensation to Underwriters | $1,180,866 | $1,710,572 | $871,285 | $1,877,070 | $181,673 | $243,887 |
Compensation to Dealers | $237,329 | $323,839 | $184,552 | $265,721 | $39,973 | $46,815 |
Compensation to Sales Personnel | $148,325 | $201,033 | $114,931 | $165,799 | $24,916 | $29,141 |
Interest, Carrying or Other Financing Charges | $0 | $0 | $0 | $0 | $0 | $0 |
Other (Includes Personnel Costs of Those Home Office Employees Involved in the Distribution Effort and the Travel-related Expenses Incurred by the Marketing Personnel Conducting Seminars) | $38,989 | $53,294 | $30,406 | $43,656 | $6,579 | $7,711 |
Totals | $1,622,557 | $2,311,948 | $1,214,395 | $2,371,272 | $256,011 | $330,915 |
Category of Expense |
Minnesota Portfolio |
New Jersey Portfolio |
Ohio Portfolio |
Pennsylvania Portfolio |
Virginia Portfolio |
Advertising/Marketing | $1,126 | $2,180 | $1,656 | $1,735 | $3,952 |
Printing and Mailing of Prospectuses and Semi-Annual and Annual Reports to Other Than Current Shareholders | $158 | $312 | $233 | $246 | $558 |
Compensation to Underwriters | $78,175 | $217,998 | $117,434 | $120,524 | $275,716 |
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Category of Expense |
Minnesota Portfolio |
New Jersey Portfolio |
Ohio Portfolio |
Pennsylvania Portfolio |
Virginia Portfolio |
Compensation to Dealers | $17,934 | $34,822 | $26,297 | $27,614 | $62,920 |
Compensation to Sales Personnel | $11,160 | $21,718 | $16,421 | $17,230 | $39,206 |
Interest, Carrying or Other Financing Charges | $0 | $0 | $0 | $0 | $0 |
Other (Includes Personnel Costs of Those Home Office Employees Involved in the Distribution Effort and the Travel-related Expenses Incurred by the Marketing Personnel Conducting Seminars) | $2,957 | $5,719 | $4,328 | $4,539 | $10,354 |
Totals | $111,510 | $282,749 | $166,369 | $171,888 | $392,707 |
Expenses incurred by each Portfolio and costs allocated to each Portfolio in connection with activities primarily intended to result in the sale of Class C shares were as follows for the period indicated:
Portfolio | Distribution Services Fees for Expenditures Payable to ABI | Percentage Per Annum
of the Aggregate Average Daily Net Assets Attributable to Class C Shares | ||||||
National | $ | 206,744 | 1.00 | % | ||||
High Income | $ | 590,316 | 1.00 | % | ||||
New York | $ | 142,756 | 1.00 | % | ||||
California | $ | 232,630 | 1.00 | % | ||||
Arizona | $ | 25,382 | 1.00 | % | ||||
Massachusetts | $ | 49,540 | 1.00 | % | ||||
Minnesota | $ | 14,592 | 1.00 | % | ||||
New Jersey | $ | 12,635 | 1.00 | % | ||||
Ohio | $ | 15,128 | 1.00 | % | ||||
Pennsylvania | $ | 7,125 | 1.00 | % | ||||
Virginia | $ | 61,398 | 1.00 | % |
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During the fiscal year ended May 31, 2024, expenses incurred by each Portfolio and costs allocated to each Portfolio in connection with activities primarily intended to result in the sale of Class C shares were as follows:
Category of Expense |
National Portfolio |
High Income Portfolio |
New York Portfolio |
California Portfolio |
Arizona Portfolio |
Massachusetts Portfolio |
Advertising/Marketing | $743 | $2,123 | $512 | $835 | $91 | $179 |
Printing and Mailing of Prospectuses and Semi-Annual and Annual Reports to Other Than Current Shareholders | $102 | $287 | $68 | $116 | $12 | $25 |
Compensation to Underwriters | $118,108 | $149,577 | $91,819 | $88,294 | $7,910 | $33,656 |
Compensation to Dealers | $11,764 | $33,571 | $8,101 | $13,261 | $1,437 | $2,811 |
Compensation to Sales Personnel | $7,265 | $20,610 | $4,924 | $8,245 | $889 | $1,745 |
Interest, Carrying or Other Financing Charges | $0 | $0 | $0 | $0 | $0 | $0 |
Other (Includes Personnel Costs of Those Home Office Employees Involved in the Distribution Effort and the Travel-related Expenses Incurred by the Marketing Personnel Conducting Seminars) | $1,942 | $5,548 | $1,344 | $2,184 | $239 | $465 |
Totals | $139,924 | $211,716 | $106,769 | $112,935 | $10,578 | $38,881 |
Category of Expense |
Minnesota Portfolio |
New Jersey Portfolio |
Ohio Portfolio |
Pennsylvania Portfolio |
Virginia Portfolio |
Advertising/Marketing | $52 | $45 | $54 | $26 | $222 |
Printing and Mailing of Prospectuses and Semi-Annual and Annual Reports to Other Than Current Shareholders | $7 | $6 | $8 | $3 | $30 |
Compensation to Underwriters | $(8,795) | $5,696 | $6,081 | $(2,240) | $9,994 |
Compensation to Dealers | $829 | $716 | $864 | $405 | $3,492 |
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Category of Expense |
Minnesota Portfolio |
New Jersey Portfolio |
Ohio Portfolio |
Pennsylvania Portfolio |
Virginia Portfolio |
Compensation to Sales Personnel | $515 | $442 | $538 | $246 | $2,174 |
Interest, Carrying or Other Financing Charges | $0 | $0 | $0 | $0 | $0 |
Other (Includes Personnel Costs of Those Home Office Employees Involved in the Distribution Effort and the Travel-related Expenses Incurred by the Marketing Personnel Conducting Seminars) | $137 | $119 | $142 | $67 | $576 |
Totals | $(7,255) | $7,023 | $7,686 | $(1,493) | $16,488 |
For the fiscal year ended May 31, 2024, cumulative unreimbursed distribution expenses incurred and carried over for reimbursement in future years in respect of the Class C shares of each Portfolio were as follows:
Class |
National Portfolio |
High Income Portfolio |
New York Portfolio |
California Portfolio |
Arizona Portfolio |
Massachusetts Portfolio |
Class C | $7,084,459 | $3,710,247 | $4,541,655 | $7,521,531 | $2,283,635 | $4,177,151 |
(% of the net assets of Class C) | 39.84% | 7.70% | 40.30% | 36.19% | 133.01% | 114.02% |
Class |
Minnesota Portfolio |
New Jersey Portfolio |
Ohio Portfolio |
Pennsylvania Portfolio |
Virginia Portfolio |
Class C | $2,873,961 | $3,846,753 | $4,087,464 | $3,606,501 | $3,517,389 |
(% of the net assets of Class C) | 234.77% | 522.54% | 272.65% | 678.28% | 69.89% |
Transfer Agency Agreements
ABIS, an indirect wholly-owned subsidiary of the Adviser, located principally at 8000 IH 10 W, 13th Floor, San Antonio, TX 78230, acts as the transfer agent for the Portfolios. ABIS registers the transfer, issuance and redemption of Portfolio shares and disburses dividends and other distributions to Portfolio shareholders.
ABIS receives a transfer agency fee per account holder of the Class A shares, Class C shares, Class Z shares and Advisor Class shares (as applicable) of each Portfolio of the Funds. The transfer agency fee with respect to the Class C shares is higher than the transfer agency fee with respect to the Class A shares, Class Z shares and Advisor Class shares. For the fiscal year ended May 31, 2024, the Fund and Fund II paid ABIS $564,317 and $133,230, respectively, under the transfer agency agreements.
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Many Portfolio shares are owned by selected dealers or selected agents, as defined below, financial intermediaries or other financial representatives (“financial intermediaries”) for the benefit of their customers. Retirement plans may also hold Portfolio shares in the name of the plan, rather than the participant. In those cases, the Portfolios often do not maintain an account for you. Thus, some or all of the transfer agency functions for these accounts are performed by the financial intermediaries. Financial intermediaries and recordkeepers, which may have affiliated financial intermediaries that sell shares of the AB Mutual Funds, may be paid by a Portfolio, the Adviser, ABI and ABIS (i) account fees in amounts up to $19 per account per annum, (ii) asset-based fees of up to 0.25% (except in respect of a limited number of intermediaries) per annum of the average daily assets held through the intermediary, or (iii) a combination of both. These amounts include fees for shareholder servicing, sub-transfer agency, sub-accounting and recordkeeping services. These amounts do not include fees for shareholder servicing that may be paid separately by a Portfolio pursuant to its Rule 12b-1 plan. Amounts paid by a Portfolio for these services are included in “Other Expenses” under “Fees and Expenses of the Portfolio” in the Summary Information section of the Prospectus. In addition, financial intermediaries may be affiliates of entities that receive compensation from the Adviser or ABI for maintaining retirement plan “platforms” that facilitate trading by affiliated and non-affiliated financial intermediaries and recordkeeping for retirement plans.
Because financial intermediaries and plan recordkeepers may be paid varying amounts per class for sub-transfer agency and related recordkeeping services, the service requirements of which may also vary by class, this may create an additional incentive for financial intermediaries and their financial advisors to favor one fund complex over another or one class of shares over another.
PURCHASE OF SHARES
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The following information supplements that set forth in the Portfolios’ Prospectus under the heading “Investing in the Portfolios”.
General
Shares of each Portfolio are offered on a continuous basis at a price equal to their NAV plus an initial sales charge at the time of purchase (“Class A shares”), without any initial sales charge and, as long as the shares are held one year or more, without any CDSC (“Class C shares”), to investors eligible to purchase Class Z shares, without any initial sales charge or CDSC (“Class Z shares”), or to investors eligible to purchase Advisor Class shares, without any initial sales charge or CDSC (“Advisor Class shares”), in each case as described below. All of the classes of shares of each Portfolio, except the Class Z and Advisor Class shares, are subject to Rule 12b-1 asset-based sales charges. Shares of each Portfolio that are offered subject to a sales charge are offered through (i) investment dealers that are members of the Financial Industry Regulatory Authority (FINRA) and have entered into selected dealer agreements with ABI (“selected dealers”), (ii) depository institutions and other financial intermediaries, or their affiliates, that have entered into selected agent agreements with ABI (“selected agents”), and (iii)
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ABI. Only the Fund Portfolios and the Arizona Portfolio, Massachusetts Portfolio and Virginia Portfolio offer Advisor Class shares.
Investors may purchase shares of a Portfolio either through financial intermediaries or directly through ABI. A transaction, service, administrative or other similar fee may be charged by your financial intermediary with respect to the purchase, sale or exchange of shares made through the financial intermediary. Such financial intermediary may also impose requirements with respect to the purchase, sale or exchange of shares that are different from, or in addition to, those imposed by the Funds, including requirements as to classes of shares available through that financial intermediary and the minimum initial and subsequent investment amounts. The Funds are not responsible for, and has no control over, the decision of any financial intermediary to impose such differing requirements. Sales personnel of financial intermediaries distributing the Funds’ shares may receive differing compensation for selling different classes of shares.
In order to open your account, each Fund or your financial intermediary is required to obtain certain information from you for identification purposes. This information may include name, date of birth, physical address, social security/taxpayer identification number and ownership/control information (for certain legal entities). Ownership/control information for legal entities may include the name, date of birth, physical address, and identification number (generally a social security or taxpayer identification number) of owners/controlling persons. It will not be possible to establish your account without this information. If a Fund or your financial intermediary is unable to verify the information provided, your account may be closed and other appropriate action may be taken as permitted by law.
Frequent Purchases and Sales of Portfolio Shares
The Funds’ Boards have adopted policies and procedures designed to detect and deter frequent purchases and redemptions of Portfolio shares or excessive or short-term trading that may disadvantage long-term Portfolio shareholders. These policies are described below. There is no guarantee that the Portfolios will be able to detect excessive or short-term trading or to identify shareholders engaged in such practices, particularly with respect to transactions in omnibus accounts. Shareholders should be aware that application of these policies may have adverse consequences, as described below, and avoid frequent trading in Portfolio shares through purchases, sales and exchanges of shares. The Portfolio reserves the right to restrict, reject or cancel, without any prior notice, any purchase or exchange order for any reason, including any purchase or exchange order accepted by any shareholder’s financial intermediary.
Risks Associated With Excessive Or Short-Term Trading Generally. While the Portfolios will try to prevent market timing by utilizing the procedures described below, these procedures may not be successful in identifying or stopping excessive or short-term trading in all circumstances. By realizing profits through short-term trading, shareholders that engage in rapid purchases and sales or exchanges of a Portfolio’s shares dilute the value of shares held by long-term shareholders. Volatility resulting from excessive purchases and sales or exchanges of Portfolio shares, especially involving large dollar amounts, may disrupt efficient portfolio management and cause a Portfolio to sell shares at inopportune times to raise cash to accommodate redemptions relating to short-term trading. In particular, a Portfolio may have
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difficulty implementing its long-term investment strategies if it is forced to maintain a higher level of its assets in cash to accommodate significant short-term trading activity. In addition, a Portfolio may incur increased administrative and other expenses due to excessive or short-term trading, including increased brokerage costs and realization of taxable capital gains.
Although the Portfolios do not invest in securities of foreign issuers, such investments may be particularly susceptible to short-term trading strategies. This is because foreign securities are typically traded on markets that close well before the time a Portfolio calculates its NAV, ordinarily at 4:00 p.m., Eastern time, which gives rise to the possibility that developments may have occurred in the interim that would affect the value of these securities. The time zone differences among international stock markets can allow a shareholder engaging in a short-term trading strategy to exploit differences in Portfolio share prices that are based on closing prices of securities of foreign issuers established some time before the Portfolio calculates its own share price (referred to as “time zone arbitrage”). The Portfolios have procedures, referred to as fair value pricing, designed to adjust closing market prices of securities of foreign issuers to reflect what is believed to be the fair value of those securities at the time a Portfolio calculates its NAV. While there is no assurance, the Portfolios expect that the use of fair value pricing, in addition to the short-term trading policies discussed below, will significantly reduce a shareholder’s ability to engage in time zone arbitrage to the detriment of other Portfolio shareholders.
The Portfolios may invest in securities that are, among other things, thinly traded or traded infrequently, or that have a limited public float and there is the risk that the current market price for the securities may not accurately reflect current market values. A shareholder may seek to engage in short-term trading to take advantage of these pricing differences (referred to as “price arbitrage”). All Portfolios may be adversely affected by price arbitrage.
Policy Regarding Short-Term Trading. Purchases and exchanges of shares of the Portfolios should be made for investment purposes only. The Portfolios seek to prevent patterns of excessive purchases and sales or exchanges of Portfolio shares. The Portfolios seek to prevent such practices to the extent they are detected by the procedures described below, subject to the Portfolios’ ability to monitor purchase, sale and exchange activity. The Portfolios reserve the right to modify this policy, including any surveillance or account blocking procedures established from time to time to effectuate this policy, at any time without notice.
· | Transaction Surveillance Procedures. The Portfolios, through their agents, ABI and ABIS, maintain surveillance procedures to detect excessive or short-term trading in Portfolio shares. This surveillance process involves several factors, which include scrutinizing transactions in Portfolio shares that exceed certain monetary thresholds or numerical limits within a specified period of time. Generally, more than two exchanges of Portfolio shares during any 60-day period or purchases of shares followed by a sale within 60 days will be identified by these surveillance procedures. For purposes of these transaction surveillance procedures, the Portfolios may consider trading activity in multiple accounts under common ownership, control or influence. Trading activity identified by either, or a combination, of these factors, or as a result of any other information available at the time, will be evaluated to determine whether such activity might constitute excessive or short-term trading. With respect to managed or discretionary accounts for which the account owner gives his/her |
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broker, investment adviser or other third party authority to buy and sell Portfolio shares, the Portfolios may consider trades initiated by the account owner, such as trades initiated in connection with bona fide cash management purposes, separately in their analysis. These surveillance procedures may be modified from time to time, as necessary or appropriate to improve the detection of excessive or short-term trading or to address specific circumstances.
· | Account Blocking Procedures. If the Portfolios determine, in their sole discretion, that a particular transaction or pattern of transactions identified by the transaction surveillance procedures described above is excessive or short-term trading in nature, the Portfolios will take remedial action that may include issuing a warning, revoking certain account-related privileges (such as the ability to place purchase, sale and exchange orders over the internet or by phone) or prohibiting or “blocking” future purchase or exchange activity. However, sales of Portfolio shares back to a Portfolio or redemptions will continue to be permitted in accordance with the terms of the Portfolio’s current Prospectus. As a result, unless the shareholder redeems his or her shares, which may have consequences if the shares have declined in value, a CDSC is applicable or adverse tax consequences may result, the shareholder may be “locked” into an unsuitable investment. A blocked account will generally remain blocked for 90 days. Subsequent detections of excessive or short-term trading may result in an indefinite account block or an account block until the account holder or the associated broker, dealer or other financial intermediary provides evidence or assurance acceptable to the Portfolio that the account holder did not or will not in the future engage in excessive or short-term trading. |
· | Applications of Surveillance Procedures and Restrictions to Omnibus Accounts. Omnibus account arrangements are common forms of holding shares of the Portfolios, particularly among certain brokers, dealers and other financial intermediaries, including sponsors of retirement plans and variable insurance products. The Portfolios apply their surveillance procedures to these omnibus account arrangements. As required by SEC rules, the Portfolios have entered into agreements with all of their financial intermediaries that require the financial intermediaries to provide the Portfolios, upon the request of the Portfolios or their agents, with individual account level information about their transactions. If the Portfolios detect excessive trading through its monitoring of omnibus accounts, including trading at the individual account level, the financial intermediaries will also execute instructions from the Portfolios to take actions to curtail the activity, which may include applying blocks to accounts to prohibit future purchases and exchanges of Portfolio shares. For certain retirement plan accounts, the Portfolios may request that the retirement plan or other intermediary revoke the relevant participant’s privilege to effect transactions in Portfolio shares via the internet or telephone, in which case the relevant participant must submit future transaction orders via the U.S. Postal Service (i.e., regular mail). |
Purchase of Shares
Each Portfolio reserves the right to suspend the sale of its shares to the public in response to conditions in the securities markets or for other reasons. If a Portfolio suspends the sale of its shares, shareholders will not be able to acquire those shares, including through an
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exchange. In addition, to the extent permitted by law, a Portfolio reserves the right to merge or reorganize itself or a share class, or to close and liquidate itself or a share class at any time.
The public offering price of shares of each Portfolio is their NAV, plus, in the case of Class A shares, a sales charge. On each Fund business day on which a purchase or redemption order is received by the Funds and trading in the types of securities in which the Portfolio invests might materially affect the value of Portfolio shares, the NAV per share is computed as of the Portfolio Closing Time, which is the close of regular trading on any day the New York Stock Exchange (the “Exchange”) is open (ordinarily 4:00 p.m., Eastern time, but sometimes earlier, as in the case of scheduled half-day trading or unscheduled suspensions of trading) by dividing the value of the Portfolio’s total assets, less its liabilities, by the total number of its shares then outstanding. A Fund business day is any day on which the Exchange is open for trading.
The respective NAVs of the various classes of shares of each Portfolio are expected to be substantially the same. However, the NAVs of the Class C shares will generally be slightly lower than the NAVs of the Class A, Class Z and Advisor Class shares as a result of the differential daily expense accruals of the higher distribution and, in some cases, transfer agency fees applicable with respect to those classes of shares.
The Funds will accept unconditional orders for shares of each Portfolio to be executed at the public offering price equal to their NAV next determined (plus applicable Class A sales charges), as described below. Orders received by ABIS prior to the Portfolio Closing Time are priced at the NAV computed as of the Portfolio Closing Time on that day (plus applicable Class A sales charges). In the case of orders for purchase of shares placed through financial intermediaries, the applicable public offering price will be the NAV as so determined, but only if the financial intermediary receives the order prior to the Portfolio Closing Time. The financial intermediary is responsible for transmitting such orders by a prescribed time to the Funds or their transfer agent. If the financial intermediary receives the order after the Portfolio Closing Time, the price received by the investor will be based on the NAV determined as of the Portfolio Closing Time on the next business day. Each Portfolio has authorized one or more brokers to receive on its behalf purchase orders. Such brokers are authorized to designate other intermediaries to receive purchase orders on the Portfolio’s behalf. In such cases, orders will receive the NAV next computed after such order is properly received by the authorized broker or designee and accepted by the Portfolio.
A Fund may, at its sole option, accept securities as payment for shares of the Fund, including from affiliates in accordance with the Fund's procedures, if the Adviser believes that the securities are appropriate investments for the Fund. The securities are valued by the method described under “Net Asset Value” below as of the date the Fund receives the securities and corresponding documentation necessary to transfer the securities to the Portfolio. This is a taxable transaction to the shareholder.
Following the initial purchase of Portfolio shares, a shareholder may place orders to purchase additional shares by telephone if the shareholder has completed the appropriate portion of the Mutual Fund Application or an “Autobuy” application obtained by calling the “For Literature” telephone number shown on the cover of this SAI. Except with respect to certain
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omnibus accounts, telephone purchase orders with payment by electronic funds transfer may not exceed $500,000. Payment for shares purchased by telephone can be made only by electronic funds transfer from a bank account maintained by the shareholder at a bank that is a member of the National Automated Clearing House Association (“NACHA”). Telephone purchase requests must be received before the Portfolio Closing Time, on a Fund business day to receive that day’s public offering price. Telephone purchase requests received after the Portfolio Closing Time, are automatically placed the following Fund business day, and the applicable public offering price will be the public offering price determined as of the Portfolio Closing Time on such following business day.
Full and fractional shares are credited to a shareholder’s account in the amount of his or her subscription. As a convenience, and to avoid unnecessary expense to a Portfolio, the Portfolio will not issue share certificates representing shares of the Portfolio. Ownership of a Portfolio’s shares will be shown on the books of the Portfolio’s transfer agent.
Each class of shares of a Portfolio represents an interest in the same portfolio of investments of the Portfolio, have the same rights and are identical in all respects, except that (i) Class A and Class C shares bear the expense of their respective CDSCs, (ii) depending on the Portfolio, Class C shares typically bear the expense of a higher distribution services fee than that borne by Class A shares, Class Z shares and Advisor Class shares which do not bear such a fee, (iii) Class C shares are subject to a conversion feature, and will convert to Class A shares under certain circumstances, and (iv) each of Class A and Class C shares has exclusive voting rights with respect to provisions of the Rule 12b-1 Plan pursuant to which its distribution services fee is paid and other matters for which separate class voting is appropriate under applicable law, provided that, if each Portfolio submits to a vote of the Class A shareholders an amendment to the Rule 12b-1 Plan that would materially increase the amount to be paid thereunder with respect to the Class A shares, then such amendment will also be submitted to Class C shareholders because the Class C shares convert to Class A shares under certain circumstances, and the Class A and Class C shareholders will vote separately by class. Each class has different exchange privileges and certain different shareholder service options available.
The Directors of the Funds have determined that currently no conflict of interest exists between or among the classes of shares of each Portfolio. On an ongoing basis, the Directors of the Funds, pursuant to their fiduciary duties under the 1940 Act and state law, will seek to ensure that no such conflict arises.
Alternative Purchase Arrangements
Classes A and C Shares. Class A and Class C shares have the following alternative purchase arrangements: Class A shares are generally offered with an initial sales charge and Class C shares are sold to investors choosing the asset-based sales charge alternative. Special purchase arrangements are available for Group Retirement Plans. “Group Retirement Plans” are defined as 401(k) plans, 457 plans, employer-sponsored 403(b) plans, profit sharing and money purchase pension plans, defined benefit plans, and non