Notes to Financial Statements
(Amounts in Thousands)
1. Significant Accounting Policies:
Western Asset Premier Bond Fund (the Fund) is registered under the Investment Company Act of 1940, as amended (the 1940 Act), as a diversified, closed-end management investment company. The
Fund commenced investment operations on March 28, 2002.
The Funds investment objective is to provide current income and capital appreciation by investing primarily in a diversified portfolio of investment grade bonds. The Fund currently seeks to achieve its investment objective by
investing substantially all of its assets in bonds, including corporate bonds, U.S. government and agency securities and mortgage-related securities. The ability of the issuers of the securities held by the Fund to meet their obligations might be
affected by, among other things, economic developments in a specific state, industry or region.
Preparation of the financial statements in accordance with accounting principles generally accepted in the United States of America requires management to
make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from those estimates. The following is a summary of significant accounting policies followed by the Fund in the
preparation of its financial statements:
Security Valuation
The Funds securities are valued on the basis of readily available market quotations or, lacking such quotations, at fair
value as determined under policies approved by and under the general oversight of the Board of Trustees. In determining fair value, all relevant qualitative and quantitative factors available are considered. These factors are subject to change over
time and are reviewed periodically. The Fund may use fair value pricing instead of market quotations to value one or more securities if the Fund believes that, because of special circumstances, doing so would more accurately reflect the prices the
Fund expects to realize on the current sale of those securities. Because of the inherent uncertainty of valuation, those estimated values may differ significantly from quoted or published values or from the values that would have been used had a
ready market for the investments existed, and the differences could be material.
With respect to the Fund, when a security is traded on more than one market, which may include foreign markets, the securities are generally valued on the market considered by the Funds adviser to be the primary
market. The Fund values its foreign securities in U.S. dollars on the basis of the then-prevailing exchange rates.
Security Transactions
Security
transactions are accounted for as of the trade date. Realized gains and losses from security transactions are reported on an identified cost basis for both financial reporting and federal income tax purposes.
For the year ended December 31, 2007, security transactions (excluding
short-term investments) were as follows:
|
|
|
|
|
|
|
|
|
|
|
Purchases
|
|
|
|
Proceeds from Sales
|
U.S. Govt. Securities
|
|
Other
|
|
|
|
U.S. Govt. Securities
|
|
Other
|
$177,285
|
|
$
|
52,819
|
|
|
|
$178,402
|
|
$
|
53,166
|
Foreign Currency
Translation
Assets and liabilities initially expressed in non-U.S. currencies are translated into U.S. dollars using currency
exchange rates determined prior to the close of trading on the New York Stock Exchange, usually at 2:00 p.m. Eastern time. Purchases and sales of securities and income and expenses are translated into U.S. dollars at the prevailing market rates on
the dates of such transactions. The effects of changes in non-U.S. currency exchange rates on investment securities and other assets and liabilities are included with the net realized and unrealized gain or loss on investment securities.
Repurchase Agreements
The Fund may engage in repurchase agreement transactions. Under the terms of a typical repurchase agreement, a fund takes possession of an underlying debt
obligation subject to an obligation of the seller to repurchase, and a fund to resell, the obligation at an agreed-upon price and time, thereby determining the yield during the funds holding period. This arrangement results in a
26
Annual Report to Shareholders
fixed rate of return that is not subject to market fluctuations during the funds holding period. The value of the collateral is at all times at least
equal to the total amount of the repurchase obligation, including interest. In the event of counterparty default, a fund has the right to use the collateral to satisfy the terms of the repurchase agreement. However, there could be potential loss to
the fund in the event the fund is delayed or prevented from exercising its right to dispose of the collateral securities, including the risk of a possible decline in the value of the collateral securities during the period in which the fund seeks to
assert its rights. The Funds investment adviser reviews the value of the collateral and the creditworthiness of those banks and dealers with which the Fund enters into repurchase agreements to evaluate potential risks.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements. Under the terms of a typical reverse repurchase agreement, a fund sells a security subject to an
obligation to repurchase the security from the buyer at an agreed-upon time and price, thereby determining the yield to the buyer during the buyers holding period. A reverse repurchase agreement involves the risk, among others, that the market
value of the collateral retained by the fund may decline below the price of the securities the fund has sold but is obligated to repurchase under the agreement. In the event the buyer of securities under a reverse repurchase agreement files for
bankruptcy or becomes insolvent, the funds use of the proceeds of the agreement may be restricted pending a determination by the party, or its trustee or receiver, whether to enforce the Funds obligation to repurchase the
securities. In entering into reverse repurchase agreements, the Fund will maintain cash, U.S. government securities or other liquid debt obligations at least equal in value to its obligations with respect to reverse repurchase agreements or will
take other actions permitted by law to cover its obligations.
Options, Futures and Swap Agreements
The current market value of an exchange traded option is the last sale
price or, in the absence of a sale, the mean between the closing bid and asked price. Futures contracts are valued daily at the settlement price established by the board of trade or exchange on which they are traded. Futures contracts are
marked-to-market on a daily basis. As the contracts value fluctuates, payments known as variation margin are made or received by the Fund each day, depending on the daily fluctuation in the value of the contract. The daily changes in contract
value are recorded as unrealized gains or losses, and the Fund recognizes a gain or loss when the contract is closed. Swap agreements are generally priced daily based upon valuations furnished by an independent pricing service and the change, if
any, is recorded as unrealized appreciation or depreciation.
Forward Currency Exchange Contracts
As part of its investment program, the Fund may utilize forward currency
exchange contracts. Forward foreign exchange contracts are marked-to-market daily using foreign currency exchange rates supplied by an independent pricing service. The change in the contracts market value is recorded by the Fund as an
unrealized gain or loss. When a contract is closed or delivery is taken, the Fund records a realized gain or loss equal to the difference between the value of the contact at the time it was opened and the value at the time it was closed.
The use of forward foreign currency exchange contracts does not eliminate
fluctuations in the underlying prices of the Funds securities, but it does establish a rate of exchange that can be achieved in the future. These forward foreign currency exchange contracts involve market risk in excess of amounts reflected in
the financial statements. Although forward foreign currency exchange contracts used for hedging purposes limit the risk of loss due to the decline in the value of the hedged currency, they also limit any potential gain that might result should the
value of the currency increase. In addition, the Fund could be exposed to risks if the counterparties to the contracts are unable to meet the terms of their contracts.
The Fund had no outstanding forward foreign currency exchange contracts as of December 31, 2007.
Short Sales
The Fund may sell a security it does not own in anticipation of a decline in the market price of that security. The Fund must then borrow the security
sold short and deliver it to the dealer that brokered the short sale. A gain, limited to the price at which the security was sold short, or a loss, potentially unlimited in size, will be recognized upon the termination of the short sale. With
respect to each short sale, the Fund must maintain collateral in a segregated account consisting of liquid assets with a value at least equal to the current market value of the shorted securities, marked-to-market daily, or take other actions
permitted by law to
27
Annual Report to Shareholders
Notes to Financial StatementsContinued
cover its obligations. Dividend expenses and fees paid to brokers to borrow securities in connection with short sales are considered part of the cost of
short sale transactions. Dividends declared on securities sold short are recorded as an expense on the ex-dividend date.
The Fund had no open short sales as December 31, 2007.
Distributions to Common Shareholders
Investment income and distributions to shareholders are recorded on the ex-dividend date. Dividends from net investment income are declared and paid monthly. Net capital gain distributions are declared and paid after the end of the tax year
in which the gain is realized. An additional distribution may be made in December to the extent necessary in order to comply with federal excise tax requirements. Distributions are determined in accordance with federal income tax regulations, which
may differ from those determined in accordance with accounting principles generally accepted in the United States of America; accordingly, periodic reclassifications are made within the Funds capital accounts to reflect income and gains
available for distribution under federal income tax regulations. Interest income and expenses are recorded on the accrual basis. Bond discounts and premiums are amortized and included in interest income for financial reporting and federal income tax
purposes.
Compensating Balance Credits
The Fund has an arrangement with its custodian bank, whereby a portion of the custodians fee is paid indirectly by credits earned on the Funds
cash on deposit with the bank. This deposit arrangement is an alternative to purchasing overnight investments.
Use of Estimates
The preparation of the financial statements in accordance with
accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from these
estimates.
Credit and Market Risk
Investments in structured securities collateralized by residential real estate mortgages are subject to certain credit and liquidity risks. When market
conditions result in an increase in default rates of the underlying mortgages and the foreclosure values of underlying real estate properties are materially below the outstanding amount of these underlying mortgages, collection of accrued interest
and principal on these investments may be doubtful. Such market conditions may significantly impair the value of these investments resulting in a lack of correlation between their credit ratings and values.
Other
In the normal course of business, the Fund enters into contracts that provide general indemnifications. The Funds maximum exposure under these
arrangements is dependent upon claims that may be made against the Fund in the future and, therefore, cannot be estimated; however, based on experience, the risk of material loss from such claims is considered remote.
2. Federal Income Taxes
It is the Funds policy to comply with the federal income and excise tax requirements of the Internal Revenue Code of 1986, as amended, applicable to
regulated investment companies. Accordingly, the Fund intends to distribute substantially all of its income and net realized gains on investments, if any, to shareholders each year. Therefore, no federal income tax provision is required in the
Funds financial statements. Under the applicable foreign tax laws, a withholding tax may be imposed on interest, dividends and capital gains at various rates.
Management has analyzed the Funds tax positions taken on federal income tax returns for all open tax years and has
concluded that as of December 31, 2007, no provision for income tax would be required in the Funds financial statements. The Funds federal and state income and federal excise tax returns for tax years for which the applicable statutes of
limitations have not expired are subject to examination by the Internal Revenue Service and state department of revenue.
28
Annual Report to Shareholders
Reclassifications
Generally Accepted
Accounting Principles (GAAP) requires that certain components of net assets be adjusted to reflect permanent differences between financial and tax reporting. These reclassifications have no effect on net assets or net asset values per
share. During the current year, the following reclassifications have been made:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Investment
Income
|
|
Accumulated Net
Realized
Loss/Gain
|
|
|
Paid-in Capital
|
|
(a)
|
|
$
|
23
|
|
$
|
|
|
|
$
|
(23
|
)
|
(b)
|
|
|
725
|
|
|
(725
|
)
|
|
|
|
|
(a)
|
|
Reclassifications are primarily due to a non-deductible excise tax paid by the Fund.
|
(b)
|
|
Reclassifications are primarily due to foreign currency transactions treated as ordinary income for tax purposes,
income from mortgage backed securities treated as capital gains for tax purposes, book/tax differences in the treatment of credit default swaps, book/tax differences in the treatment of stepped coupon security and book/tax differences in the
treatment of various items.
|
Distributions to
Shareholders:
The tax character of distributions paid during the fiscal year ended December 31 were as follows:
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
Distributions paid from:
|
|
|
|
|
|
|
Ordinary Income
|
|
$
|
14,734
|
|
$
|
16,088
|
Net Long-term Capital Gains
|
|
|
3,210
|
|
|
2,281
|
|
|
|
|
|
|
|
Total Distributions Paid
|
|
$
|
17,944
|
|
$
|
18,369
|
|
|
|
|
|
|
|
Accumulated Earnings on a Tax
Basis:
As of December 31, 2007, the components of accumulated earnings on a tax basis were as follows:
|
|
|
|
|
Undistributed ordinary incomenet
|
|
$
|
464
|
|
Undistributed long-term capital gainsnet
|
|
|
467
|
|
|
|
|
|
|
Total undistributed earnings
|
|
$
|
931
|
|
Other book/tax temporary differences
|
|
|
247
|
(a)
|
Unrealized Appreciation / Depreciation
|
|
|
(124
|
)
(b)
|
|
|
|
|
|
Total accumulated earnings / (losses)net
|
|
$
|
1,054
|
|
|
|
|
|
|
(a)
Other
|
|
book/tax temporary differences are attributable primarily to the tax deferral of losses on straddles, the realization
for tax purposes of unrealized gains / (losses) on certain futures contracts and the deferral of post-October losses on credit default swaps for tax purposes, and differences in the book/tax treatment of various items.
|
(b)
The
|
|
difference between book-basis and tax-basis unrealized appreciation / (depreciation) is attributable primarily to the
tax deferral of losses on wash sales and other book/tax basis adjustments.
|
Tax Cost of Investments:
As of December 31, 2007, the aggregate cost of investments for federal income tax
purposes was $246,937
3. Financial Instruments:
Option Transactions
As part of its investment program, the Fund may utilize options. Options may be written (sold) or purchased by the Fund. When the Fund purchases a put or
call option, the premium paid is recorded as an investment and its value is marked-to-market daily. When the Fund writes a put or call option, an amount equal to the premium received by the Fund is recorded as a liability and its value is
marked-to-market daily.
29
Annual Report to Shareholders
Notes to Financial StatementsContinued
When options, whether written or purchased, expire, are exercised or are closed (by entering into a closing purchase or sale transaction), the Fund realizes a gain or loss as described in the chart below:
|
|
|
Purchased option:
|
|
Impact on the Fund:
|
The option expires
|
|
Realize a loss in the amount of the cost of the option.
|
The option is closed through a closing sale transaction
|
|
Realize a gain or loss depending on whether the proceeds from the closing sale transaction are greater or less than the cost of the
option.
|
The Fund exercises a call option
|
|
The cost of the security purchased through the exercise of the option will be increased by the premium originally paid to purchase the
option.
|
The Fund exercises a put option
|
|
Realize a gain or loss from the sale of the underlying security. The proceeds of that sale will be reduced by the premium originally paid to purchase the
put option.
|
|
|
Written option:
|
|
Impact on the Fund:
|
The option expires
|
|
Realize a gain equal to the amount of the premium received.
|
The option is closed through a closing purchase transaction
|
|
Realize a gain or loss without regard to any unrealized gain or loss on the underlying security and eliminate the option liability. The Fund will realize
a loss in this transaction if the cost of the closing purchase exceeds the premium received when the option was written.
|
A written call option is exercised by the option purchaser
|
|
Realize a gain or loss from the sale of the underlying security. The proceeds of that sale will be increased by the premium originally received when the
option was written.
|
A written put option is exercised by the option purchaser
|
|
The amount of the premium originally received will reduce the cost of the security that the Fund purchased when the option was exercised.
|
The risk associated
with purchasing options is limited to the premium originally paid. Options written by the Fund involve, to varying degrees, risk of loss in excess of the option value reflected in the statement of assets and liabilities. The risk in writing a
covered call option is that the Fund may forgo the opportunity of profit if the market price of the underlying security increases and the option is exercised. The risk in writing a put option is that the Fund may incur a loss if the market price of
the underlying security decreases and the option is exercised. In addition, there is the risk the Fund may not be able to enter into a closing transaction because of an illiquid secondary market or, for over-the-counter options, because of the
counterpartys inability to perform.
There was no
activity in written options during the year ended December 31, 2007.
Futures
Upon entering into a futures contract, the Fund is required to deposit with the broker cash or cash
equivalents in an amount equal to a certain percentage of the contract amount. This is known as the initial margin. Subsequent payments (variation margin) are made or received by the Fund each day, depending on the daily
fluctuation in the value of the contract. The daily changes in contract value are recorded as unrealized gains or losses and the Fund recognizes a realized gain or loss when the contract is closed. Futures contracts are valued daily at the
settlement price established by the board of trade or exchange on which they are traded.
The Fund may enter into futures contracts as a hedge against anticipated changes in interest rates. There are several risks in connection with the use of futures contracts as a hedging device. Futures contracts
involve, to varying degrees, risk of loss in excess of the amounts reflected in the financial statements. The change in the value of futures contracts primarily corresponds with the value of their underlying instruments, which may not correlate with
the change in the value of the hedged instruments. In addition, there is the risk that a Fund may not be able to enter into a closing transaction because of an illiquid secondary market.
The open futures positions and related appreciation or depreciation at
December 31, 2007 are listed at the end of the Funds portfolio of investments.
30
Annual Report to Shareholders
Reverse Repurchase Agreements
As of
December 31, 2007, the Fund had entered into a reverse repurchase agreement (Reverse Repurchase Agreement) with Deutsche Bank. The Reverse Repurchase Agreement, which matured on January 15, 2008, was recorded at cost and was
collateralized by U.S. Government securities and corporate bonds with a par value of $13,770 and a market value as of December 31, 2007, of $16,254.
For the year ended December 31, 2007, the average amount of reverse repurchase agreement outstanding was $19,241 and the daily weighted average interest
rate was 5.01%.
|
|
|
|
|
|
|
|
|
Broker
|
|
Interest Rate
|
|
|
Maturity
|
|
Amount
|
Deutsche Bank
|
|
3.9
|
%
|
|
1/15/08
|
|
$
|
3,901
|
Deutsche Bank
|
|
3.9
|
|
|
1/15/08
|
|
|
3,232
|
Deutsche Bank
|
|
3.9
|
|
|
1/15/08
|
|
|
3,446
|
Deutsche Bank
|
|
3.9
|
|
|
1/15/08
|
|
|
3,027
|
Deutsche Bank
|
|
3.9
|
|
|
1/15/08
|
|
|
2,599
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
16,205
|
|
|
|
|
|
|
|
|
|
Swap Agreements
The Fund may invest in swaps for the purpose of managing their exposure to interest rate, credit or market risk, or for other purposes. The
use of swaps involves risks that are different from those associated with ordinary portfolio transactions.
Credit default swaps involve the exchange of a fixed rate premium for protection against the loss in value of an underlying debt instrument in the event
of a defined credit event (such as payment default or bankruptcy). Under the terms of the swap, one party acts as a guarantor, receiving a periodic payment that is a fixed percentage applied to a notional principal amount. In return, the
party agrees to purchase the notional amount of the underlying instrument, at par, if a credit event occurs during the term of the swap. The Fund may enter into credit default swaps in which the Fund or its counterparty act as guarantors. By acting
as the guarantor of a swap, the Fund assumes the market and credit risk of the underlying instrument, including liquidity and loss of value.
Swaps are marked-to-market daily and changes in value are recorded as unrealized appreciation/(depreciation). Gains or losses are realized upon
termination of the swap agreement. Periodic payments and premiums received or made by a Fund are recorded in the accompanying statement of operations as realized gains or losses, respectively. Collateral, in the form of restricted cash or
securities, may be required to be held in segregated accounts with the Funds custodian in compliance with the terms of the swap contracts. Risks may exceed amounts recognized on the statement of assets and liabilities. These risks include
changes in the returns of the underlying instruments, failure of the counterparties to perform under the contracts terms, and the possible lack of liquidity with respect to the swap agreements.
If the Fund is a seller of protection and a credit event occurs, as defined
under the terms of the particular swap agreement, the Fund will pay to the buyer of the protection an amount up to the notional value of the swap and in certain instances, take delivery of the security.
31
Annual Report to Shareholders
Notes to Financial StatementsContinued
As of December 31, 2007, the one-month London Interbank Offered Rate (LIBOR) was 4.60%.
The following is a summary of open credit default swap contracts outstanding as of December 31, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
Agreement With:
|
|
Termination Date
|
|
The Fund
Agrees to Pay
|
|
The Fund
Will Receive
|
|
Contract
Notional Amount
|
|
Unrealized
Appreciation/
(Depreciation)
|
Credit Suisse First Boston USA (AAMES Mortgage Investment Trust 2005-1 M8, 1-Month LIBOR + 160 basis points (bp)
C
, due 6/25/35)
|
|
June 25, 2035
|
|
1.28%
Monthly
|
|
Specified Amount upon credit event notice
|
|
$
|
43
|
|
$
|
19
|
|
|
|
|
|
|
Credit Suisse First Boston USA (AAMES Mortgage Investment Trust 2005-1 M9, 1-Month LIBOR + 250 bp, due 6/25/35)
|
|
June 25, 2035
|
|
2.05%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
23
|
|
|
|
|
|
|
Credit Suisse First Boston USA (ACE Securities Corp. 2005-HE1 M8, 1-Month LIBOR + 138 bp, due 2/25/35)
|
|
February 25, 2035
|
|
1.31%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
10
|
|
|
|
|
|
|
Credit Suisse First Boston USA (ACE Securities Corp. 2005-HE1 M9, 1-Month LIBOR + 220 bp, due 2/25/35)
|
|
February 25, 2035
|
|
2.06%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
12
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Aegis Asset Backed Securities Trust 2004-4 B2, 1-Month
LIBOR + 190 bp, due 10/25/34)
|
|
October 25, 2034
|
|
1.37%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
37
|
|
|
16
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Aegis Asset Backed Securities Trust 2005 B2, 1-Month LIBOR + 130 bp, due 3/25/35)
|
|
March 25, 2035
|
|
1.31%
Quarterly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
32
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Aegis Asset Backed Securities Trust 2005 B3, 1-Month LIBOR + 200 bp, due 3/25/35)
|
|
March 25, 2035
|
|
2.18%
Quarterly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
36
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Argent Securities Inc. 2004-W11 M10, 1-Month
LIBOR + 350 bp, due 11/25/34)
|
|
November 25, 2034
|
|
2.15%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
7
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Argent Securities Inc. 2004-W11 M9, 1-Month LIBOR + 225 bp, due 11/25/34)
|
|
November 25, 2034
|
|
1.33%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
7
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Argent Securities Inc. 2004-W4 M3, 1-Month LIBOR + 300 bp, due 3/25/34)
|
|
March 25, 2034
|
|
2.2%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
21
|
|
|
9
|
C
|
|
100 basis points = 1.00%
|
32
Annual Report to Shareholders
|
|
|
|
|
|
|
|
|
|
|
|
|
Agreement With:
|
|
Termination Date
|
|
The Fund
Agrees to Pay
|
|
The Fund
Will Receive
|
|
Contract
Notional Amount
|
|
Unrealized
Appreciation/
(Depreciation)
|
Credit Suisse First Boston USA (Finance America Mortgage Loan Trust 2004-3 M8, 1-Month LIBOR + 180 bp, due 11/25/34)
|
|
November 25, 2034
|
|
1.31%
Monthly
|
|
Specified Amount upon credit event notice
|
|
$
|
16
|
|
$
|
11
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Finance America Mortgage Loan Trust 2004-3 M9, 1-Month LIBOR + 315 bp, due 11/25/34)
|
|
November 25, 2034
|
|
2.18%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
16
|
|
|
12
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Fremont Home Loan Trust 2005-A M8, 1-Month LIBOR + 135 bp, due 1/25/35)
|
|
January 25, 2035
|
|
1.31%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
4
|
|
|
1
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Fremont Home Loan Trust 2005-A, 1-Month LIBOR + 100 bp, due 1/25/35)
|
|
January 25, 2035
|
|
2.08%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
7
|
|
|
2
|
|
|
|
|
|
|
Credit Suisse First Boston USA (IndyMac Home Equity Loan Asset-Backed, Trust 2004-C M8, 1-Month LIBOR + 190 bp, due
3/25/35)
|
|
March 25, 2035
|
|
1.28%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
14
|
|
|
|
|
|
|
Credit Suisse First Boston USA (IndyMac Home Equity Loan Asset-Backed, Trust 2004-C M9, 1-Month LIBOR + 325 bp, due
3/25/35)
|
|
March 25, 2035
|
|
2.05%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
15
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Long Beach Mortgage Loan Trust 2004-1 M9, 1-Month LIBOR + 350 bp, due 2/25/34)
|
|
February 25, 2034
|
|
2.15%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
17
|
|
|
7
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Long Beach Mortgage Loan Trust 2005-1 M8, 1-Month LIBOR + 170 bp, due 2/25/35)
|
|
February 25, 2035
|
|
1.31%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
13
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Long Beach Mortgage Loan Trust 2005-1 M9, 1-Month LIBOR + 275 bp, due 2/25/35)
|
|
February 25, 2035
|
|
2.08%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
16
|
|
|
|
|
|
|
Credit Suisse First Boston USA (MASTR Asset Backed Securities Trust 2005-NC1 M8, 1-Month LIBOR + 153 bp,
due
12/25/34)
|
|
December 25, 2034
|
|
1.31%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
22
|
33
Annual Report to Shareholders
Notes to Financial StatementsContinued
|
|
|
|
|
|
|
|
|
|
|
|
|
Agreement With:
|
|
Termination Date
|
|
The Fund
Agrees to Pay
|
|
The Fund
Will Receive
|
|
Contract
Notional Amount
|
|
Unrealized
Appreciation/
(Depreciation)
|
Credit Suisse First Boston USA (MASTR Asset Backed Securities Trust 2005-NC1 M9, 1-Month LIBOR + 240 bp,
due
12/25/34)
|
|
December 25, 2034
|
|
2.08%
Monthly
|
|
Specified Amount upon credit event notice
|
|
$
|
43
|
|
$
|
15
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Merrill Lynch Mortgage Investors, Inc. 2004-WMC1 B3, 1-Month LIBOR + 225 bp, due
9/25/35)
|
|
September 25, 2035
|
|
2.05%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
7
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Merrill Lynch Mortgage Investors, Inc. 2004-WMC4 B3, 1-Month LIBOR + 375 bp, due
4/25/35)
|
|
April 25, 2035
|
|
2.15%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
58
|
|
|
13
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Merrill Lynch Mortgage Investors, Inc. 2005-NC1 B2, 1-Month LIBOR + 130 bp,
due
10/25/35)
|
|
October 25, 2035
|
|
1.28%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
6
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Merrill Lynch Mortgage Investors, Inc. 2005-NC1 B3, 1-Month LIBOR + 205 bp,
due
10/25/35)
|
|
October 25, 2035
|
|
2.05%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
8
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Merrill Lynch Mortgage Investors, Inc. 2005-WMC1 B2, 1-Month LIBOR + 135 bp, due
9/25/35)
|
|
September 25, 2035
|
|
1.28%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
43
|
|
|
10
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Morgan Stanley ABS Capital I 2005-WMC1 B2, 1-Month LIBOR + 130 bp, due 1/25/35)
|
|
January 25, 2035
|
|
1.31%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
14
|
|
|
10
|
|
|
|
|
|
|
Credit Suisse First Boston USA (Morgan Stanley ABS Capital I 2005-WMC1 B3, 1-Month LIBOR + 215 bp, due 1/25/35)
|
|
January 25, 2035
|
|
2.18%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
16
|
|
|
13
|
|
|
|
|
|
|
Credit Suisse First Boston USA (New Century Home Equity Loan Trust 2004-2 M9, 1-Month LIBOR + 325 bp,
due
8/25/34)
|
|
August 25, 2034
|
|
2.15%
Monthly
|
|
Specified Amount upon credit event notice
|
|
|
22
|
|
|
5
|
34
Annual Report to Shareholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agreement With:
|
|
Termination Date
|
|
The Fund
Agrees to Pay
|
|
The Fund
Will Receive
|
|
Contract
Notional Amount
|
|
Unrealized
Appreciation/
(Depreciation)
|
|
Credit Suisse First Boston USA
(New Century Home Equity Loan Trust 2005-1 M8, 1-Month LIBOR + 140 bp,
due 3/25/35)
|
|
March 25, 2035
|
|
1.31%
Monthly
|
|
Specified Amount upon credit
event notice
|
|
$
|
43
|
|
$
|
6
|
|
|
|
|
|
|
|
Credit Suisse First Boston USA
(New Century Home Equity Loan Trust 2005-1 M9, 1-Month LIBOR + 205 bp,
due 3/25/35)
|
|
March 25, 2035
|
|
2.18%
Monthly
|
|
Specified Amount upon credit
event notice
|
|
|
43
|
|
|
13
|
|
|
|
|
|
|
|
Credit Suisse First Boston USA
(Novastar Home Equity Loan 2005-1 B2, 1-Month LIBOR + 135 bp, due 6/25/35)
|
|
June 25, 2035
|
|
1.28%
Monthly
|
|
Specified Amount upon credit
event notice
|
|
|
43
|
|
|
12
|
|
|
|
|
|
|
|
Credit Suisse First Boston USA
(Novastar Home Equity Loan 2005-4 B3, 1-Month LIBOR + 195 bp, due 6/25/35)
|
|
June 25, 2035
|
|
2.05%
Monthly
|
|
Specified Amount upon credit
event notice
|
|
|
43
|
|
|
20
|
|
|
|
|
|
|
|
Credit Suisse First Boston USA
(Park Place Securities Inc. 2005-WCH1 M8, 1-Month LIBOR + 155 bp, due 1/25/36)
|
|
January 25, 2036
|
|
1.36%
Monthly
|
|
Specified Amount upon credit
event notice
|
|
|
43
|
|
|
20
|
|
|
|
|
|
|
|
Credit Suisse First Boston USA
(Park Place Securities, Inc. 2005-WCH1 M9, 1-Month LIBOR + 250 bp, due 1/25/36)
|
|
January 25, 2036
|
|
2.18%
Monthly
|
|
Specified Amount upon credit
event notice
|
|
|
43
|
|
|
24
|
|
|
|
|
|
|
|
Credit Suisse First Boston USA
(Peoples Choice Home Loan Securities Trust 2004-1 M6, 1-Month LIBOR + 230 bp,
due 6/25/34)
|
|
June 25, 2034
|
|
1.37%
Quarterly
|
|
Specified Amount upon credit
event notice
|
|
|
58
|
|
|
10
|
|
|
|
|
|
|
|
Credit Suisse First Boston USA
(Peoples Choice Home Loan Securities Trust 2005-1 B3, 1-Month LIBOR + 260 bp,
due 1/25/35)
|
|
January 25, 2035
|
|
2.05%
Monthly
|
|
Specified Amount upon credit
event notice
|
|
|
43
|
|
|
20
|
|
|
|
|
|
|
|
Credit Suisse First Boston USA
(Peoples Choice Home Loan Securities Trust 2005-1, 1-Month LIBOR + 165 bp,
due
1/25/35)
|
|
January 25, 2035
|
|
1.28% Monthly
|
|
Specified Amount upon credit
event notice
|
|
|
43
|
|
|
17
|
|
|
|
|
|
|
|
Deutsche Bank AG
(ABX. HE-AAA 06-2)
|
|
May 25, 2046
|
|
Specified Amount upon credit
event notice
|
|
0.11% Monthly
|
|
|
300
|
|
|
(25
|
)
|
35
Annual Report to Shareholders
Notes to Financial StatementsContinued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agreement With:
|
|
Termination Date
|
|
The Fund
Agrees to Pay
|
|
The Fund
Will Receive
|
|
Contract
Notional Amount
|
|
Unrealized
Appreciation/
(Depreciation)
|
|
JP Morgan Chase & Co. (ABX.HE-AAA 07-2)
|
|
January 25, 2038
|
|
Specified Amount upon credit
event notice
|
|
0.76% Monthly
|
|
$
|
20,000
|
|
$
|
(4,679
|
)
|
|
|
|
|
|
|
Merrill Lynch & Co., Inc.
(CDX HY 8)
|
|
June 20, 2012
|
|
Specified Amount upon credit
event notice
|
|
0.86% Quarterly
|
|
|
30,000
|
|
|
75
|
|
|
|
|
|
|
|
Merrill Lynch & Co., Inc.
(CDX HY 8)
|
|
June 20, 2012
|
|
Specified Amount upon credit
event notice
|
|
1.135% Quarterly
|
|
|
10,000
|
|
|
127
|
|
|
|
|
|
|
|
Merrill Lynch & Co., Inc.
(CDX HY 8)
|
|
June 20, 2012
|
|
Specified Amount upon credit
event notice
|
|
1.4% Quarterly
|
|
|
15,000
|
|
|
336
|
|
|
|
|
|
|
|
Merrill Lynch & Co., Inc.
(iBoxx IG)
|
|
June 20, 2010
|
|
Specified Amount upon credit
event notice
|
|
0.4% Quarterly
|
|
|
15,000
|
|
|
(72
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
91,704
|
|
$
|
(3,725
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4. Common Shares
(amounts are not in thousands):
Of the
11,469,943 shares of common stock outstanding at December 31, 2007, Western Asset owns 10,539 shares.
5. Preferred Shares
(amounts are not in thousands):
There are 2,880 shares of Auction Market Preferred Shares (Preferred Shares) authorized. The Preferred Shares have rights as set forth in the
Funds Agreement and Declaration of Trust, as amended to date, and its Bylaws, as amended to date (the Bylaws), or as otherwise determined by the Trustees. The 2,880 Preferred Shares outstanding consist of two series, 1,440 shares
of Series M and 1,440 shares of Series W. The Preferred Shares have a liquidation value of $25,000 per share, plus any accumulated but unpaid dividends whether or not earned or declared.
Dividends on the Series M and Series W Preferred Shares are cumulative and are paid at a rate typically reset every seven
and twenty-eight days, respectively, based on the results of an auction. Dividend rates ranged from 4.85% to 6.50% between January 1, 2007 to December 31, 2007. Under the Investment Company Act of 1940, the Fund may not declare dividends or
make other distributions on common shares or purchase any such shares if, at the time of the declaration, distribution or purchase, asset coverage with respect to the outstanding Preferred Shares would be less than 200%.
The Preferred Shares are redeemable at the option of the Fund, in whole or in
part, on the second business day preceding any dividend payment date at $25,000 per share plus any accumulated but unpaid dividends. The Preferred Shares are also subject to mandatory redemption at $25,000 per share plus any accumulated but unpaid
dividends, whether or not earned or declared, if certain requirements relating to the composition of the assets and liabilities of the Fund as set forth in the Bylaws are not satisfied.
Preferred shareholders, who are entitled to one vote per Preferred Share, generally vote as a single class with the common
shareholders, but will vote separately as a class (and, in certain circumstances, vote separately by series) with respect to certain matters set forth in the Bylaws. The preferred shareholders are entitled to elect two Trustees of the Fund.
6. Securities Lending
Subject to applicable restrictions in the Funds Bylaws, the Fund may lend its securities to approved brokers to earn additional income, and will
receive cash and U.S. government securities as collateral against the loans. Cash collateral received is invested in a money market pooled account by the Funds lending agent. Collateral is maintained over the life of the loan in an amount not
less than 100% of the value of the loaned securities. As of December 31, 2007, there were no securities on loan.
36
Annual Report to Shareholders
7. Transactions with Affiliates:
The Fund has a
management agreement with Western Asset Management Company (Western Asset). Pursuant to the terms of the management agreement, the Fund pays Western Asset an annual fee, payable monthly, in an amount equal to 0.55% of the average weekly
value of the Funds total managed assets. Total managed assets means the total assets of the Fund (including any assets attributable to leverage) minus accrued liabilities. The liquidation preference of any Preferred Shares
outstanding is not considered a liability. Pursuant to a Portfolio Management Agreement between Western Asset and Western Asset Management Company Limited (WAML), Western Asset pays a portion of the fees it receives from the Fund to WAML
at an annual rate of 0.425% of the average weekly value of the Funds total managed assets that WAML manages. Western Asset and WAML are wholly owned subsidiaries of Legg Mason, Inc.
On May 1, 2007, Legg Mason Fund Adviser, Inc. replaced Princeton Administrators, LLC (Princeton) as
administrator for the Fund. Under the terms of the Administration Agreement among the Fund, Western Asset and Legg Mason Fund Adviser, Inc. (LMFA), Western Asset pays LMFA, a monthly fee at an annual rate of 0.125% of the Funds
average weekly total managed assets, subject to a monthly minimum fee of $12,500. The compensation arrangements between the Fund and LMFA are identical to the previous arrangements between the Fund and Princeton.
8. Trustee Compensation
(amounts are not in
thousands):
Each Independent Trustee receives an aggregate fee of $60,000
annually for serving on the combined Board of Trustees/Directors of the Fund, Western Asset Income Fund and Western Asset Funds, Inc. Each Trustee also receives a fee of $7,500 and related expenses for each meeting of the Board attended in-person
and a fee of $2,500 for participating in each telephonic meeting. The Chairman of the Board and the Chairman of the Audit Committee each receive an additional $25,000 per year for serving in such capacities. Each member of the Audit Committee
receives a fee of $5,000 for serving as a member of the Audit Committee. Other committee members receive $2,500 for serving as a member of each committee upon which they serve. Committee members also receive a fee of $2,500 for participating in each
telephonic committee meeting. All such fees are allocated among the Fund, Western Asset Income Fund and Western Asset Funds, Inc. according to each such investment companys average annual net assets. Mr. Olson receives from Western Asset
an aggregate fee of $60,000 annually for serving on the combined Board of Trustees/Directors of the Fund, Western Asset Income Fund and Western Asset Funds, Inc., as well as a fee of $7,500 and related expenses for each meeting of the Board attended
in person and a fee of $2,500 for participating in each telephonic meeting.
9. Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation 48 (FIN 48 or the Interpretation),
Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement 109
. FIN 48 supplements FASB Statement 109,
Accounting for Income Taxes
and establishes financial reporting rules regarding recognition, measurement, presentation, and disclosure in its financial statements of tax positions that a fund has taken or expects to take on a tax return. FIN 48 became effective for fiscal
periods beginning after December 15, 2006. Effective January 1, 2007, the Fund adopted FIN 48. There was no material impact to the financial statements or disclosure thereto as a result of this adoption.
On September 20, 2006, the FASB released Statement of Financial Accounting
Standards No. 157 Fair Value Measurements (FAS 157). FAS 157 establishes an authoritative definition of fair value, sets out a framework for measuring fair value, and requires additional disclosures about fair-value
measurements. The application of FAS 157 is required for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Management has evaluated the implications of FAS 157 and does not believe the adoption of FAS 157
will materially impact the amounts recorded in the financial statements, however, additional disclosure will be required in subsequent reports.
37
Annual Report to Shareholders