For the second quarter ended June 30, 2005, the performance of FPA New Income, Inc. was, in a word, lousy. As we have always done at First Pacific Advisors, Inc., we tell you both the good and the bad news, when it occurs. We are unlike many other investment organizations that tend to focus on telling their story only when it is positive. Through our process, we hope and expect that all shareholders of the FPA Funds and clients of FPA gain a better understanding, appreciation and confidence in us.

FPA New Income experienced a negative total return of 0.36%, or 36 basis points, for the second quarter while the bond market’s total return, as measured by the Merrill Lynch U.S. Corporate & Government Master Index, was a positive 3.47%. We expected to underperform in the second quarter because the Fund’s average duration of less than one year is significantly shorter than the 5.2 years of the Merrill Lynch Index. With falling interest rates, the longer duration will provide a better total return. In our case, our poor performance was being driven by something more than just a significantly shorter portfolio duration.

We determined that there were three areas that were the primary causes of our poor performance and these subtracted nearly 1% from the Fund’s second-quarter performance.

In order of importance, high-yield was the most significant culprit. We lost approximately 69 basis points of performance from just this one area. Our bond holdings in one company, Collins & Aikman Products, accounted for 74% of this loss or 51 basis points. (We wrote about this situation in the March 2005 Shareholder Letter.) Since then, we have sold virtually all of these securities, because we determined that their recovery potential was minimal, if anything at all, for the junior securities. We hold an 11-basis-point position in the senior notes. As such, the Fund will not likely face much in the way of any further losses from this situation. We also reviewed the remaining high-yield holdings, and the lead analyst on each holding is confident that the securities are adequately protected. High-yield accounts for only 4.9% of the portfolio, with barely 2% having any real credit risk.

The second contributor was our exposure to Interest Only securities, or IOs. We have used them over the last fifteen years to help stabilize the Fund’s volatility. Their value changes in the opposite direction of how a typical bond would move during interest-rate shifts. Because interest rates fell in the second quarter, our IOs declined in value, and they subtracted about 27 basis points from the Fund’s performance. During May, we sold the majority of these holdings, since our analysis indicated that the potential upside return versus the downside risk was approximately equal. We do not like investment situations where the risk/return trade-off is even. Furthermore, we have been wrong about the direction of long-term interest rates for nearly two years. They have behaved in a fashion that is totally at odds with historical experience. Given that we believe that there are factors affecting the movement of interest rates that are beyond normal fundamentals, we felt that it would be unwise to maintain our existing strategy, as it pertains to these securities. The remaining holdings, less than 1% of the portfolio, are significantly better structured to withstand short-term interest-rate volatility than the ones that we sold.

Finally, our French inflation indexed bond subtracted approximately 3 basis points of performance. During the quarter, the euro fell almost 7% versus the dollar, and this decline overwhelmed the interest income we earned. We remain interested in selected foreign securities as a possible area for future investment, since we remain concerned about the long-term value of the dollar.

FPA New Income’s very poor second-quarter performance was, in our opinion, atypical for us, and we believe we have addressed the issues that caused this situation. As an example of our expected performance, during July, bond yields began to rise again, with the ten-year Treasury bond yield up 36 basis points to 4.28%. In light of this change, the bond market’s total return for the month, as reflected by the Merrill Lynch Index, was a negative 1.18%, while FPA New Income was a positive 0.27%. This better reflects how the Fund has performed in the past under similar circumstances. Our restructuring of the portfolio has essentially eliminated those items that harmed us in the second quarter, and thus we believe it is well positioned to withstand the negative effects from rising interest rates or disruptions in the high-yield bond market. Preservation of capital remains paramount in our thinking. We hope this commentary helps you to understand what occurred as well as the actions that we have taken to correct the situation.

Sincerely,

Robert L. Rodriguez, CFA

President and Chief Investment Officer

August 2, 2005

Note that the returns quoted for FPA New Income, Inc. are calculated at net asset value and adjusted for dividends paid during the period. These returns do not include the maximum sales charge of 3.5%, which, if included, would reduce the performance shown.