UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-06179
Flaherty & Crumrine Preferred Income Fund Incorporated
(Exact name of registrant as specified in charter)
301 E. Colorado Boulevard, Suite 720
Pasadena, CA 91101
(Address of principal executive offices) (Zip code)
Donald F. Crumrine
Flaherty & Crumrine Incorporated
301 E. Colorado Boulevard, Suite 720
Pasadena, CA 91101
(Name and address of agent for service)
registrant's telephone number, including area code: 626-795-7300
Date of fiscal year end: November 30
Date of reporting period: November 30, 2010
Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. Section 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
FLAHERTY & CRUMRINE PREFERRED INCOME FUND
To the Shareholders of Flaherty & Crumrine Preferred Income Fund:
We begin with good news about distributions on your shares of PFD--the Fund
finished fiscal 2010 with a bit of extra income, so shareholders of record on
December 23, 2010 received an additional $0.03 per share. In addition, the
regular monthly distribution was increased to $0.09 from $0.089 per share
beginning with the December dividend(1).
During the Fund's final fiscal quarter, the portfolio once again turned in
solid performance. For the three-month period ending November 30, 2010, the
Fund's return on net asset value was +5.5%. Over the entire fiscal year, the
return on NAV was +31.5%. The table below presents these and other performance
measures of interest to investors.
TOTAL RETURN ON NET ASSET VALUE
FOR PERIODS ENDED NOVEMBER 30, 2010
ACTUAL RETURNS AVERAGE ANNUALIZED RETURNS
---------------------- -------------------------------
THREE SIX ONE THREE FIVE TEN LIFE OF
MONTHS MONTHS YEAR YEARS YEARS YEARS FUND(1)
------ ------ ---- ----- ----- ----- -------
Flaherty & Crumrine Preferred Income Fund ..... 5.5% 18.3% 31.5% 7.4% 3.6% 7.0% 9.5%
Barclays Capital U.S. Aggregate Index(2) ...... -0.1% 3.9% 6.0% 6.4% 6.2% 6.2% 6.9%
S&P 500 Index(3) .............................. 13.1% 9.5% 9.9% -5.2% 1.0% 0.8% 8.6%
----------
(1) Since inception on January 31, 1991.
(2) The Barclays Capital U.S. Aggregate Index represents securities that are
SEC-registered, taxable, and dollar denominated. The index covers the U.S.
investment grade fixed rate bond market, with index components for
government and corporate securities, mortgage pass-through securities, and
asset-backed securities. It is generally considered to be representative of
the domestic, investment-grade, fixed-rate, taxable bond market. Unless
otherwise noted, index returns reflect the reinvestment of dividends and
capital gains, if any, but do not reflect fees, brokerage commissions or
other expenses of investing. This index was formerly known as the Lehman
Brothers U.S. Aggregate Index.
(3) The S&P 500 is a capitalization-weighted index of 500 common stocks. The
index is designed to measure performance of the broad domestic economy
through changes in the aggregate market value of 500 stocks representing
all major industries.
The Fund's strong performance during the quarter was accomplished despite a
weak market for US Treasury bonds and continued uncertainty about changes in
regulation of the banking industry.
Conditions in the market for preferred securities are still positive.
Demand is broad based and steady, while most participants expect the size of the
market to decline (at least over the near-term). The market has also been
boosted by steady improvement in the financial strength of many issuers as,
corporate profitability has steadily improved.
----------
(1) A more in-depth discussion of the dividend and other important topics can
be found in the section which follows our letter.
SHORT-TERM interest rates remain near zero as economic activity remains
positive but stubbornly slow. Unemployment rates are high, and the impact of
fiscal and monetary actions has been more muted than desired. We anticipate
short-term interest rates (and hence the cost of the Fund's leverage) will
remain low over the near-term; however, eventually they will go up. Our view is
detailed in the Quarterly Economic Outlook available on the Fund's website.
Yields on LONG-TERM U.S. Treasury bonds increased almost 60 basis points
during the period; prices fell roughly 10%. Clearly, concerns about a pick-up in
economic activity, inflation, or both, have become more widespread. In the past,
a move of this magnitude typically caused some corresponding drop in the prices
of preferred securities. Obviously, the recent period was not typical--most
preferred prices actually went up in the face of falling bond prices. The
correlation between prices of preferred securities and treasury bonds used to be
reliably high, but this has not been the case for much of the past three years
(a major reason the Fund suspended its hedging strategy in autumn 2008).
As discussed previously, the financial crisis brought to light a need to
rethink the role of capital in the banking industry. Regulators and policy
makers are debating the amount and composition of capital necessary to prevent a
repeat of the crisis. Preferred securities play a very important part in the
debate. This is a complex matter and there are a lot of chefs in the kitchen; it
will likely take many more months before the process is complete. However, some
change is certain and we are managing the portfolio to reflect things we know
and some we anticipate. We remain optimistic the ultimate outcome will be
beneficial over the long term.
As always, we encourage you to visit www.preferredincome.com to read our
Quarterly Economic Update as well as a more detailed discussion of factors
affecting the wonderful world of preferred securities.
Sincerely,
/s/ Donald F. Crumrine /s/ Robert M. Ettinger
------------------------------------ -----------------------------------------
Donald F. Crumrine Robert M. Ettinger
Chairman President
January 10, 2011
2
DISCUSSION TOPICS
THE FUND'S PORTFOLIO RESULTS AND COMPONENTS OF TOTAL RETURN ON NAV
The table below reflects the performance of each investment technique
available for use by the Fund to achieve its objective, namely: (a) investing in
a portfolio of securities; (b) hedging that portfolio of securities against
significant increases in long-term interest rates (see the following discussion
on the status of the Fund's interest rate hedging strategy); and (c) utilizing
leverage to enhance returns to shareholders. Next, we compute the impact of the
Fund's operating expenses. All of the parts are summed to determine total return
on NAV.
COMPONENTS OF PFD'S TOTAL RETURN ON NAV
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 2010
SIX MONTHS* ONE YEAR
----------- --------
Total Return on Unleveraged Securities Portfolio
(including principal and income) ............... +12.9% +22.4%
Return from Interest Rate Hedging Strategy ........ N/A N/A
Impact of Leverage (including leverage expense) ... +6.2% +10.7%
Expenses (excluding leverage expense) ............. -0.8% -1.6%%
------ ------
TOTAL RETURN ON NAV ............................ +18.3% +31.5%
====== ======
* Actual, not annualized.
The following table displays returns for the various segments of the
preferred securities market as measured by BofA Merrill preferred indices, over
both the past six months and the Fund's fiscal year ended November 30th. During
these periods, the preferred market continued the price recovery that began in
early 2009, but at a somewhat slower pace. As can be seen by comparing the total
return on the Fund's securities portfolio (the first row of the above table) to
the index results below, the Fund's portfolio outperformed all segments of the
preferred market over its fiscal year ending November 30th, even excluding the
impact of leverage. During the past six months, the Fund's (unleveraged)
securities portfolio outperformed all segments of the preferred market except
adjustable rate preferred securities, which constitute only about 2.5% of the
entire preferred market and just 2.3% of the Fund's portfolio.
TOTAL RETURNS OF BANK OF AMERICA MERRILL LYNCH PREFERRED SECURITIES INDICES*
FOR THE PERIODS ENDED NOVEMBER 30, 2010
SIX MONTHS ONE YEAR
---------- --------
BofA Merrill Lynch 8% Capped DRD Preferred Stock Index(SM) ................. +8.2% +16.9%
BofA Merrill Lynch 8% Capped Hybrid Preferred Securities Index(SM) ......... +10.8% +18.8%
BofA Merrill Lynch 8% Capped Corporate U.S. Capital Securities Index(SM) ... +10.8% +19.7%
BofA Merrill Lynch Adjustable Preferred Stock, 7% Constrained Index(SM) .... +13.5% +16.3%
* The Bank of America Merrill Lynch 8% Capped DRD Preferred Stock Index(SM)
includes investment grade preferred securities issued by both corporations
and government agencies that qualify for the corporate dividends received
deduction with issuer concentration capped at a maximum of 8%. The Bank of
America Merrill Lynch 8% Capped Hybrid Preferred Securities Index(SM)
includes taxable, fixed-rate, U.S. dollar-denominated investment-grade,
preferred securities listed on a U.S. exchange with issuer concentration
capped at 8%. The Bank of America Merrill Lynch 8% Capped Corporate U.S.
Capital Securities Index(SM) includes investment grade fixed rate or
fixed-to-floating rate $1,000 par securities that receive some degree of
equity credit from the rating agencies or their regulators with issuer
concentration capped at a maximum of 8%. The Bank of America Merrill Lynch
Adjustable Preferred Stock, 7% Constrained Index(SM) includes adjustable
rate preferred securities issued by U.S. corporations and government
agencies with issuer concentration capped at a maximum of 7%. All index
returns include interest and dividend income, and, unlike the Fund's
returns, are unmanaged and do not reflect any expenses.
3
As shown in the first table, the Fund's performance demonstrates how
leverage again benefited common stock shareholders over the past year -
increasing current income and magnifying the positive returns over the Fund's
fiscal 2010. Although leverage can adversely impact Fund results in unfavorable
market environments, during the recent fiscal year leverage assisted the Fund's
NAV in significantly outperforming returns available in the preferred securities
market, as measured by the various BofA Merrill preferred indices.
TOTAL RETURN ON MARKET PRICE OF FUND SHARES
While our focus is primarily on managing the Fund's investment portfolio,
an investor's actual return is comprised of monthly dividend payments plus
changes in the Fund's MARKET PRICE. During the twelve months ending November 30,
2010, the total return on market price of Fund shares was +43.6%.
FLAHERTY & CRUMRINE PREFERRED INCOME FUND(PFD)
PREMIUM/DISCOUNT OF MARKET PRICE TO NAV THROUGH 12/31/2010
(PERFORMANCE GRAPH)
2/8/91 0.0842
2/15/91 0.0438
2/22/91 0.0395
3/1/91 0.0424
3/8/91 0.0183
3/15/91 0.0151
3/22/91 0.0201
3/29/91 0.023
4/5/91 0.0149
4/12/91 0.0196
4/19/91 0.0314
4/26/91 0.0268
5/3/91 0.023
5/10/91 0.0199
5/17/91 0.0146
5/24/91 0.0219
5/31/91 0.051
6/7/91 0.0423
6/14/91 0.0417
6/21/91 0.0536
6/28/91 0.0659
7/5/91 0.0726
7/12/91 0.0659
7/19/91 0.0643
7/26/91 0.0549
8/2/91 0.0678
8/9/91 0.054
8/16/91 0.0449
8/23/91 0.0648
8/30/91 0.0314
9/6/91 0.057
9/13/91 0.0883
9/20/91 0.0651
9/27/91 0.0682
10/4/91 0.0764
10/11/91 0.0745
10/18/91 0.0719
10/25/91 0.0662
11/1/91 0.0693
11/8/91 0.0827
11/15/91 0.0801
11/22/91 0.065
11/29/91 0.0807
12/6/91 0.0716
12/13/91 0.0791
12/20/91 0.0839
12/27/91 0.1136
1/3/92 0.1091
1/10/92 0.1116
1/17/92 0.0978
1/24/92 0.0912
1/31/92 0.0417
2/7/92 0.0478
2/14/92 0.0613
2/21/92 0.0417
2/28/92 0.0381
3/6/92 0.0339
3/13/92 0.0447
3/20/92 0.0387
3/27/92 0.0327
4/3/92 0.0357
4/10/92 0.0452
4/17/92 0.0464
4/24/92 0.0423
5/1/92 0.0523
5/8/92 0.0382
5/15/92 0.0347
5/22/92 0.0083
5/29/92 0.0039
6/5/92 0.0302
6/12/92 0.0239
6/19/92 0.0227
6/26/92 0.0491
7/3/92 0.0491
7/10/92 0.0593
7/17/92 0.057
7/24/92 0.0712
7/31/92 0.058
8/7/92 0.0601
8/14/92 0.0389
8/21/92 0.0306
8/28/92 0.025
9/4/92 0.0228
9/11/92 0.0356
9/18/92 0.0489
9/25/92 0.0339
10/2/92 0.065
10/9/92 0.0417
10/16/92 0.0417
10/23/92 0.0378
10/30/92 0.0707
11/6/92 0.0378
11/13/92 0.059
11/20/92 0.0349
11/27/92 0.0506
12/4/92 0.068
12/11/92 0.0601
12/18/92 0.0582
12/25/92 0.0618
1/1/93 0.0739
1/8/93 0.0987
1/15/93 0.1145
1/22/93 0.1021
1/29/93 0.076
2/5/93 0.053
2/12/93 0.0452
2/19/93 0.0434
2/26/93 0.0628
3/5/93 0.0909
3/12/93 0.0538
3/19/93 0.0248
3/26/93 0.0638
4/2/93 0.0806
4/9/93 0.0764
4/16/93 0.0671
4/23/93 0.0764
4/30/93 0.0677
5/7/93 0.0918
5/14/93 0.0779
5/21/93 0.07
5/28/93 0.074
6/4/93 0.0497
6/11/93 0.0388
6/18/93 0.056
6/25/93 0.0703
7/2/93 0.0451
7/9/93 0.0541
7/16/93 0.049
7/23/93 0.0576
7/30/93 0.0598
8/6/93 0.079
8/13/93 0.0484
8/20/93 0.0377
8/27/93 0.0434
9/3/93 0.045
9/10/93 0.0361
9/17/93 0.0467
9/24/93 0.0321
10/1/93 0.0293
10/8/93 0.011
10/15/93 0.0173
10/22/93 0.0048
10/29/93 -0.0075
11/5/93 0.0095
11/12/93 0.0019
11/19/93 -0.0316
11/26/93 0.003
12/3/93 -0.0175
12/10/93 -0.0103
12/17/93 0.0323
12/24/93 -0.0051
12/31/93 -0.0287
1/7/94 0.0093
1/14/94 0.0149
1/21/94 -0.0126
1/28/94 -0.0316
2/4/94 -0.0196
2/11/94 -0.0224
2/18/94 -0.0741
2/25/94 -0.0539
3/4/94 -0.0092
3/11/94 -0.027
3/18/94 -0.0379
3/25/94 -0.0505
4/1/94 -0.0466
4/8/94 -0.0713
4/15/94 -0.0596
4/22/94 -0.0598
4/29/94 -0.0863
5/6/94 -0.0581
5/13/94 -0.0635
5/20/94 -0.0409
5/27/94 -0.0397
6/3/94 -0.0289
6/10/94 0.0146
6/17/94 -0.0037
6/24/94 0.0175
7/1/94 0.0006
7/8/94 0.0299
7/15/94 0.0188
7/22/94 -0.0084
7/29/94 -0.0082
8/5/94 -0.0161
8/12/94 -0.0215
8/19/94 -0.0263
8/26/94 -0.0439
9/2/94 -0.0379
9/9/94 -0.0232
9/16/94 -0.0293
9/23/94 -0.0273
9/30/94 -0.0565
10/7/94 -0.1141
10/14/94 -0.1089
10/21/94 -0.1416
10/28/94 -0.0732
11/4/94 -0.0783
11/11/94 -0.0912
11/18/94 -0.0951
11/25/94 -0.0788
12/2/94 -0.0593
12/9/94 -0.0508
12/16/94 -0.0554
12/23/94 -0.0822
12/30/94 -0.0836
1/6/95 -0.0201
1/13/95 -0.0134
1/20/95 -0.0525
1/27/95 -0.0697
2/3/95 0.0061
2/10/95 -0.0289
2/17/95 -0.0419
2/24/95 -0.0004
3/3/95 0.0035
3/10/95 -0.0445
3/17/95 -0.0666
3/24/95 -0.0568
3/31/95 -0.029
4/7/95 -0.0256
4/14/95 -0.0217
4/21/95 -0.0439
4/28/95 -0.0271
5/5/95 -0.0398
5/12/95 -0.0178
5/19/95 -0.041
5/26/95 -0.087
6/2/95 -0.0259
6/9/95 -0.0608
6/16/95 -0.0759
6/23/95 -0.0884
6/30/95 -0.0753
7/7/95 -0.0844
7/14/95 -0.0995
7/21/95 -0.0976
7/28/95 -0.0917
8/4/95 -0.0888
8/11/95 -0.0935
8/18/95 -0.0942
8/25/95 -0.0832
9/1/95 -0.0698
9/8/95 -0.0816
9/15/95 -0.0968
9/22/95 -0.0978
9/29/95 -0.0816
10/6/95 -0.0974
10/13/95 -0.1094
10/20/95 -0.1048
10/27/95 -0.121
11/3/95 -0.1151
11/10/95 -0.1146
11/17/95 -0.1117
11/24/95 -0.1043
12/1/95 -0.1071
12/8/95 -0.1192
12/15/95 -0.1244
12/22/95 -0.1337
12/29/95 -0.1313
1/5/96 -0.1365
1/12/96 -0.1354
1/19/96 -0.1379
1/26/96 -0.1251
2/2/96 -0.1244
2/9/96 -0.1238
2/16/96 -0.136
2/23/96 -0.1281
3/1/96 -0.1118
3/8/96 -0.1332
3/15/96 -0.1521
3/22/96 -0.1564
3/29/96 -0.1464
4/5/96 -0.1343
4/12/96 -0.1477
4/19/96 -0.1402
4/26/96 -0.1488
5/3/96 -0.1477
5/10/96 -0.1452
5/17/96 -0.1363
5/24/96 -0.1432
5/31/96 -0.1111
6/7/96 -0.118
6/14/96 -0.1003
6/21/96 -0.1129
6/28/96 -0.1049
7/5/96 -0.095
7/12/96 -0.098
7/19/96 -0.1071
7/26/96 -0.1077
8/2/96 -0.1105
8/9/96 -0.0574
8/16/96 -0.0714
8/23/96 -0.0705
8/30/96 -0.0669
9/6/96 -0.0824
9/13/96 -0.0756
9/20/96 -0.1186
9/27/96 -0.1106
10/4/96 -0.0861
10/11/96 -0.0941
10/18/96 -0.1077
10/25/96 -0.0858
11/1/96 -0.0778
11/8/96 -0.0831
11/15/96 -0.0833
11/22/96 -0.0653
11/29/96 -0.0606
12/6/96 -0.0667
12/13/96 -0.0831
12/20/96 -0.0749
12/27/96 -0.075
1/3/97 -0.0242
1/10/97 -0.0291
1/17/97 -0.0465
1/24/97 -0.041
1/31/97 -0.0459
2/7/97 -0.0675
2/14/97 -0.0544
2/21/97 -0.0539
2/28/97 -0.055
3/7/97 -0.0584
3/14/97 -0.0637
3/21/97 -0.0752
3/28/97 -0.0584
4/4/97 -0.0627
4/11/97 -0.0881
4/18/97 -0.0976
4/25/97 -0.0852
5/2/97 -0.0451
5/9/97 -0.0578
5/16/97 -0.0529
5/23/97 -0.0554
5/30/97 -0.0541
6/6/97 -0.051
6/13/97 -0.0486
6/20/97 -0.0486
6/27/97 -0.0429
7/4/97 -0.0308
7/11/97 -0.0537
7/18/97 -0.0583
7/25/97 -0.0519
8/1/97 -0.0498
8/8/97 -0.0583
8/15/97 -0.0708
8/22/97 -0.0739
8/29/97 -0.0469
9/5/97 -0.0595
9/12/97 -0.0623
9/19/97 -0.0651
9/26/97 -0.0604
10/3/97 -0.0299
10/10/97 -0.0385
10/17/97 -0.0477
10/24/97 -0.0558
10/31/97 -0.0517
11/7/97 -0.0425
11/14/97 -0.0554
11/21/97 -0.067
11/28/97 -0.0313
12/5/97 -0.0431
12/12/97 -0.0519
12/19/97 -0.0632
12/26/97 -0.0621
1/2/98 -0.009
1/9/98 -0.0211
1/16/98 -0.0012
1/23/98 -0.0431
1/30/98 -0.0358
2/6/98 -0.0364
2/13/98 -0.0474
2/20/98 -0.0466
2/27/98 -0.0446
3/6/98 -0.048
3/13/98 -0.0595
3/20/98 -0.0437
3/27/98 -0.0518
4/3/98 -0.0645
4/10/98 -0.0509
4/17/98 -0.058
4/24/98 -0.0663
5/1/98 -0.0422
5/8/98 -0.0589
5/15/98 -0.0681
5/22/98 -0.0702
5/29/98 -0.0496
6/5/98 -0.0556
6/12/98 -0.0586
6/19/98 -0.0599
6/26/98 -0.0479
7/3/98 -0.0496
7/10/98 -0.0558
7/17/98 -0.0565
7/24/98 -0.0645
7/31/98 -0.0503
8/7/98 -0.0614
8/14/98 -0.0779
8/21/98 -0.075
8/28/98 -0.0448
9/4/98 -0.0448
9/11/98 -0.0379
9/18/98 -0.0326
9/25/98 -0.0367
10/2/98 -0.0379
10/9/98 -0.0249
10/16/98 -0.0228
10/23/98 -0.0117
10/30/98 -0.0091
11/6/98 -0.014
11/13/98 -0.0423
11/20/98 -0.0394
11/27/98 -0.0267
12/4/98 -0.0373
12/11/98 -0.0212
12/18/98 -0.0355
12/25/98 -0.0127
1/1/99 -0.0106
1/8/99 -0.0182
1/15/99 -0.0372
1/22/99 -0.0557
1/29/99 -0.0557
2/5/99 -0.0536
2/12/99 -0.0687
2/19/99 -0.0647
2/26/99 -0.1014
3/5/99 -0.0826
3/12/99 -0.0747
3/19/99 -0.0935
3/26/99 -0.106
4/2/99 -0.0802
4/9/99 -0.0969
4/16/99 -0.1003
4/23/99 -0.0957
4/30/99 -0.0946
5/7/99 -0.0962
5/14/99 -0.0928
5/21/99 -0.1146
5/28/99 -0.1048
6/4/99 -0.1014
6/11/99 -0.0991
6/18/99 -0.0927
6/25/99 -0.1031
7/2/99 -0.0979
7/9/99 -0.0938
7/16/99 -0.1037
7/23/99 -0.0747
12/9/05 -0.0751
12/2/05 -0.0792
11/25/05 -0.0963
11/18/05 -0.0946
11/11/05 -0.0911
11/4/05 -0.1071
10/28/05 -0.0892
10/21/05 -0.1065
10/14/05 -0.0788
10/7/05 -0.0703
9/30/05 -0.0727
9/23/05 -0.1442
9/16/05 -0.1279
9/9/05 -0.1431
9/2/05 -0.1368
8/26/05 -0.1373
8/19/05 -0.1078
8/12/05 -0.1207
8/5/05 -0.1115
7/29/05 -0.1164
7/22/05 -0.1277
7/15/05 -0.1624
7/8/05 -0.1084
7/1/05 -0.0771
6/24/05 -0.0451
6/17/05 -0.1203
6/10/05 -0.1392
6/3/05 -0.0511
5/27/05 -0.0641
5/20/05 -0.0872
5/13/05 -0.0812
5/6/05 -0.0585
4/29/05 -0.0526
4/22/05 -0.0706
4/15/05 -0.1058
4/8/05 -0.1052
4/1/05 -0.0782
3/25/05 -0.0904
3/18/05 -0.0868
3/11/05 -0.0757
3/4/05 -0.0591
2/25/05 -0.0608
2/18/05 -0.0438
2/11/05 -0.0407
2/4/05 -0.0482
1/28/05 -0.0639
1/21/05 -0.067
1/14/05 -0.0678
1/7/05 -0.08
12/31/04 -0.0807
12/24/04 -0.0755
12/17/04 -0.0842
12/10/04 -0.0816
12/3/04 -0.0851
11/26/04 -0.0865
11/19/04 -0.0672
11/12/04 -0.0851
11/5/04 -0.0681
10/29/04 -0.0794
10/22/04 -0.0858
10/15/04 -0.0905
10/8/04 -0.1071
10/1/04 -0.0866
9/24/04 -0.0872
9/17/04 -0.0845
9/10/04 -0.0695
9/3/04 -0.0571
8/27/04 -0.0734
8/20/04 -0.0991
8/13/04 -0.1379
8/6/04 -0.0864
7/30/04 -0.0877
7/23/04 -0.1171
7/16/04 -0.0939
7/9/04 -0.0965
7/2/04 -0.0328
6/25/04 0.0028
6/18/04 -0.0285
6/11/04 -0.036
6/4/04 -0.0414
5/28/04 -0.029
5/21/04 -0.0314
5/14/04 -0.0321
5/7/04 0.0007
4/30/04 -0.0517
4/23/04 -0.0586
4/16/04 -0.0288
4/9/04 -0.0203
4/2/04 -0.0094
3/26/04 0.0117
3/19/04 -0.0229
3/12/04 -0.0088
3/5/04 0.0072
2/27/04 -0.0146
2/20/04 0.0029
2/13/04 -0.016
2/6/04 0.018
1/30/04 -0.0215
1/23/04 -0.0405
1/16/04 -0.0503
1/9/04 -0.0258
1/2/04 0.0064
12/26/03 -0.041
12/19/03 0.0021
12/12/03 0.0308
12/5/03 -0.0175
11/28/03 -0.0473
11/21/03 -0.0282
11/14/03 -0.0221
11/7/03 -0.0475
10/31/03 -0.0007
10/24/03 -0.0007
10/17/03 -0.0173
10/10/03 -0.012
10/3/03 0.0069
9/26/03 0.023
9/19/03 -0.009
9/12/03 0.0275
9/5/03 0.0089
8/29/03 0.0034
8/22/03 0.0178
8/15/03 0.022
8/8/03 -0.0096
8/1/03 0.0138
7/25/03 0.0152
7/18/03 0.043
7/11/03 0.0271
7/4/03 0.0437
6/27/03 0.0323
6/20/03 0.0447
6/13/03 0.0608
6/6/03 0.0754
5/30/03 0.0924
5/23/03 0.0755
5/16/03 0.1158
5/9/03 0.1186
5/2/03 0.0395
4/25/03 0.0437
4/18/03 0.0212
4/11/03 0.0212
4/4/03 0.0246
3/28/03 0.0423
3/21/03 0.0539
3/14/03 0.0312
3/7/03 0.0468
2/28/03 0.0408
2/21/03 0.0434
2/14/03 0.0542
2/7/03 0.0543
1/31/03 0.0704
1/24/03 0.0505
1/17/03 0.0478
1/10/03 0.087
1/3/03 0.0691
12/27/02 0.0545
12/20/02 0.1276
12/13/02 0.1241
12/6/02 0.1051
11/29/02 0.0865
11/22/02 0.1032
11/15/02 0.1103
11/8/02 0.1209
11/1/02 0.1169
10/25/02 0.0972
10/18/02 0.0948
10/11/02 0.0932
10/4/02 0.111
10/11/02 0.1724
10/18/02 0.0412
10/25/02 0.0914
11/1/02 0.0724
11/8/02 0.1039
11/15/02 0.1113
11/22/02 0.055
11/29/02 0.1005
12/6/02 0.1217
12/13/02 0.0917
12/20/02 0.1085
12/27/02 0.1129
1/3/03 0.1149
1/10/03 0.0859
1/17/03 0.1459
1/24/03 0.1461
1/31/03 0.1557
2/7/03 0.1483
2/14/03 0.1544
2/21/03 0.145
2/28/03 0.1285
3/7/03 0.1442
3/14/03 0.1508
3/21/03 0.1146
3/28/03 0.1098
4/4/03 0.1478
4/11/03 0.1382
4/18/03 0.1384
4/25/03 0.1251
5/2/03 0.0749
5/9/03 0.0459
5/16/03 0.0373
5/23/03 0.0371
5/30/03 0.0701
6/6/03 0.0286
6/13/03 0.0336
6/20/03 0.0453
6/27/03 0.0483
7/4/03 0.0605
7/11/03 0.0217
7/18/03 0.009
7/25/03 0.002
8/1/03 -0.0282
8/8/03 -0.0206
8/15/03 -0.023
8/22/03 -0.0148
8/29/03 -0.0019
9/5/03 0.0026
9/12/03 -0.0051
9/19/03 -0.0151
9/26/03 -0.0393
10/3/03 -0.0233
10/10/03 -0.0196
10/17/03 -0.0309
10/24/03 -0.022
10/31/03 0.0314
11/7/03 0.0076
11/14/03 0.0413
11/21/03 0.0882
11/28/03 0.1136
8/11/06 0.1202
8/4/06 0.1321
7/28/06 0.1348
7/21/06 0.1471
7/14/06 0.155
7/7/06 0.1432
6/30/06 0.1418
6/23/06 0.1599
6/16/06 0.1306
6/9/06 0.134
6/2/06 0.1366
5/26/06 0.1633
5/19/06 0.1588
5/12/06 0.1749
5/5/06 0.169
4/28/06 0.1859
4/21/06 0.2086
4/14/06 0.181
4/7/06 0.0637
3/31/06 0.0453
3/24/06 0.0119
3/17/06 0.0107
3/10/06 -0.0108
3/3/06 0.0206
2/24/06 0.0682
2/17/06 0.1405
2/10/06 0.118
2/3/06 0.1393
1/27/06 0.1446
1/20/06 0.1479
1/13/06 0.139
1/6/06 0.1269
12/30/05 0.1148
12/23/05 0.1175
12/16/05 0.0982
12/9/05 0.1063
12/2/05 0.1201
11/25/05 0.1635
11/18/05 0.1613
11/11/05 0.1708
11/4/05 0.1722
10/28/05 0.1653
10/21/05 0.1349
10/14/05 0.1391
10/7/05 0.1691
9/30/05 0.1668
9/23/05 0.1718
9/16/05 0.1626
9/9/05 0.1553
9/2/05 0.1617
8/26/05 0.1706
8/19/05 0.1659
8/12/05 0.098
8/5/05 0.0919
7/29/05 0.1169
7/22/05 0.1499
7/15/05 0.1485
7/8/05 0.1541
7/1/05 0.1296
6/24/05 0.1385
6/17/05 0.1461
6/10/05 0.1303
6/3/05 0.1475
5/27/05 0.1687
5/20/05 0.1578
5/13/05 0.13
5/6/05 0.1076
4/29/05 0.0069
4/22/05 -0.0114
4/15/05 0.0025
4/8/05 0.0214
4/15/05 0.0206
4/22/05 0.0056
4/29/05 0.0449
5/6/05 0.0592
5/13/05 0.0462
5/20/05 0.0477
5/27/05 0.047
6/3/05 0.0546
6/10/05 0.0631
6/17/05 0.0377
6/24/05 0.0456
7/1/05 0.0848
7/8/05 0.1081
7/15/05 0.1289
7/22/05 0.1312
7/29/05 0.1009
8/5/05 0.1136
8/12/05 0.1132
8/19/05 0.1237
8/26/05 0.1152
9/2/05 0.1153
9/9/05 0.1387
9/16/05 0.1465
9/23/05 0.1068
9/30/05 0.0504
10/7/05 0.0924
10/14/05 0.0507
10/21/05 0.0378
10/28/05 0.0252
11/4/05 0.0262
11/11/05 0.0502
11/18/05 0.0698
11/25/05 0.0885
12/2/05 0.0479
12/9/05 0.0603
12/16/05 0.047
12/23/05 0.0461
12/30/05 0.0462
1/6/06 0.0636
1/13/06 0.0542
1/20/06 0.0823
1/27/06 0.0977
2/3/06 0.0877
2/10/06 0.0797
2/17/06 0.0775
2/24/06 0.0689
3/3/06 0.0945
3/10/06 0.0561
3/17/06 0.0425
3/24/06 0.0388
3/31/06 0.0442
4/7/06 0.0384
4/14/06 0.0162
4/21/06 0.0065
4/28/06 0.021
5/5/06 0.0256
5/12/06 0.0355
5/19/06 0.0242
5/26/06 0.0205
6/2/06 0.0244
6/9/06 0.0013
6/16/06 0.014
6/23/06 0.0228
6/30/06 0.0167
7/7/06 0.0073
7/14/06 0.0073
7/21/06 0.0413
7/28/06 0.0605
8/4/06 0.0603
8/11/06 0.074
8/18/06 0.0552
8/25/06 0.0672
9/1/06 0.0869
9/8/06 0.0773
9/15/06 0.0778
9/22/06 0.0616
9/29/06 0.07
10/6/06 0.0924
10/13/06 0.0805
10/20/06 0.0841
10/27/06 0.0695
11/3/06 0.0722
11/10/06 0.071
11/17/06 0.0739
11/24/06 0.0843
12/1/06 0.0601
12/8/06 0.077
12/15/06 0.0785
12/22/06 0.0789
12/29/06 0.0835
1/5/07 0.0842
1/12/07 0.1124
1/19/07 0.1108
1/26/07 0.1283
2/2/07 0.1076
2/9/07 0.1283
2/16/07 0.0955
2/23/07 0.1051
3/2/07 0.0724
3/9/07 0.0751
3/16/07 0.0679
3/23/07 0.1049
3/30/07 0.1061
4/5/07 0.1342
4/13/07 0.1107
4/20/07 0.1115
4/27/07 0.1005
5/4/07 0.0777
5/11/07 0.0415
5/18/07 0.0523
5/25/07 0.0594
6/1/07 0.0726
6/8/07 0.0618
6/15/07 0.0896
6/22/07 0.0967
6/29/07 0.0761
7/6/07 0.0543
7/13/07 0.0388
7/20/07 0.0385
7/27/07 0.0836
8/3/07 0.0789
8/10/07 0.0406
8/17/07 -0.0186
8/24/07 0.0227
8/31/07 -0.0042
9/7/07 0.0119
9/14/07 0.0351
9/21/07 0.0527
9/28/07 0.0352
10/5/07 0.0466
10/12/07 -0.0147
10/19/07 -0.0333
10/26/07 -0.012
11/2/07 -0.0401
11/9/07 -0.084
11/16/07 -0.0359
11/23/07 -0.0448
11/30/07 -0.0342
12/7/07 -0.041
12/14/07 -0.0496
12/21/07 -0.0189
12/28/07 -0.031
1/4/08 -0.0063
1/11/08 -0.0195
1/18/08 -0.0078
1/25/08 0.0804
2/1/08 -0.0115
2/8/08 0.0016
2/15/08 -0.0508
2/22/08 -0.0345
2/29/08 -0.0491
3/7/08 -0.0076
3/14/08 -0.0617
3/20/08 -0.0411
3/28/08 -0.0564
4/4/08 -0.0664
4/11/08 -0.0675
4/18/08 -0.0617
4/25/08 0.0054
5/2/08 -0.015
5/9/08 -0.0279
5/16/08 0.0088
5/23/08 0.0329
5/30/08 0.052
6/6/08 0.0422
6/13/08 0.0287
6/20/08 0.0439
6/27/08 -0.0048
6/30/08 0.0156
7/3/08 -0.0069
7/11/08 -0.0199
7/18/08 0.12
7/25/08 0.0516
8/1/08 0.0625
8/8/08 0.0896
8/15/08 0.0744
8/22/08 0.0905
8/29/08 0.0792
9/5/08 0.084
9/12/08 0.1344
9/19/08 0.1288
9/26/08 0.1181
10/3/08 -0.2996
10/10/08 -0.513
10/17/08 -0.173
10/24/08 -0.3108
10/31/08 -0.1351
11/7/08 -0.1248
11/14/08 -0.2504
11/21/08 -0.3508
11/28/08 -0.0518
12/5/08 -0.2147
12/12/08 -0.099
12/19/08 -0.0248
12/26/08 -0.0939
12/31/08 -0.0923
1/2/09 -0.0061
1/9/09 0.1595
1/16/09 0.0361
1/23/09 0.0225
1/30/09 0.1595
2/6/09 0.2017
2/13/09 0.175
2/20/09 0.0882
2/27/09 0.0626
3/6/09 -0.1789
3/13/09 0.0188
3/20/09 -0.01
3/27/09 0.0557
3/31/09 0.0377
4/3/09 0.0738
4/9/09 0.0265
4/17/09 0.1143
4/24/09 0.1366
5/1/09 0.0653
5/8/09 0.0714
5/15/09 0.045
5/22/09 0.0751
5/29/09 0.0237
6/5/09 0.0704
6/12/09 0.0515
6/19/09 0.0747
6/26/09 0.0522
6/30/09 0.0471
7/2/09 0.0221
7/10/09 -0.0219
7/17/09 0.1455
7/24/09 0.0594
7/31/09 -0.0086
8/7/09 -0.0272
8/14/09 -0.0104
8/21/09 0
8/28/09 0.0012
8/31/09 -0.0263
9/4/09 0.0012
9/11/09 -0.0281
9/18/09 -0.0099
9/25/09 -0.015
9/30/09 0.0032
10/2/09 0
10/9/09 -0.0063
10/16/09 0
10/23/09 -0.0329
10/30/09 -0.071
11/6/09 -0.0663
11/13/09 -0.0338
11/20/09 -0.0614
11/27/09 -0.0642
11/30/09 -0.0713
12/4/09 -0.0639
12/11/09 -0.0643
12/18/09 0.0119
12/24/09 0.0523
12/31/09 0.0155
1/8/10 0.0181
1/15/10 0.0196
1/22/10 -0.0019
1/29/10 0.0067
2/5/10 -0.0143
2/12/10 0.0592
2/19/10 0.081
2/26/10 0.0656
3/5/10 0.0708
3/12/10 0.022
3/19/10 0.0825
3/26/10 0.059
3/31/10 0.0217
4/1/10 0.0396
4/9/10 0.0625
4/16/10 0.0141
4/23/10 0.0442
4/30/10 0.0614
5/7/10 -0.0205
5/14/10 0.0534
5/21/10 0
5/28/10 0.0181
6/4/10 0.0323
6/11/10 0.0682
6/18/10 0.0607
6/25/10 0.0808
6/30/10 0.061
7/2/10 0.0432
7/9/10 0.0753
7/16/10 0.0401
7/23/10 0.0545
7/30/10 0.1058
8/6/10 0.0954
8/13/10 0.0975
8/20/10 0.0961
8/27/10 0.0619
8/31/10 0.0766
9/3/10 0.0825
9/10/10 0.1275
9/17/10 0.1422
9/24/10 0.0809
9/30/10 0.1151
10/8/10 0.0963
10/15/10 0.1133
10/22/10 0.0751
10/29/10 0.0525
11/5/10 0.0565
11/12/10 0.0324
11/19/10 0.0302
11/26/10 0.0177
11/30/10 0.0143
12/3/10 -0.0017
12/10/10 -0.0364
12/17/10 -0.0246
12/23/10 -0.012
12/31/10 -0.0169
In a perfect world, the market price of Fund shares would closely track the
Fund's net asset value. As can be seen from the graph above, this often is not
the case. For most of the past year the MARKET PRICE has been above the NAV (in
market parlance, "trading at a premium"). Because the Fund began fiscal 2010
with its market price below NAV ("trading at a discount") and ended the fiscal
year above, the total return earned on market price exceeded the total return on
NAV.
Based on a closing price of $11.62 on December 31st, the current annualized
yield on the market price of the Fund's shares (assuming the current monthly
distribution of $0.09 does not change) is 9.29%. In our opinion, this
distribution rate measures up favorably with most comparable investment
opportunities.
PREFERRED MARKET CONDITIONS
By most measures, preferred market trading conditions are back to
pre-crisis levels. Trading volumes and bid/offer spreads, though never robust
compared to other major market segments, have returned to more customary levels.
In our opinion, preferred securities remain attractively valued relative to
other fixed income securities; plus, we are still finding opportunities to add
value through credit research and security selection.
4
Credit conditions continue to improve. The economy is growing fast enough
for profits to rebound nicely, but not fast enough to generate much demand for
new capital spending by corporations. Households are paying down debt, driving
investors who had previously purchased mortgage and credit card debt into other
asset classes. Corporations are showing strong cash flow, improved interest
coverage, and growing liquidity. Loan quality is improving, with delinquencies
and charge-offs falling in almost all loan categories--though commercial real
estate remains an important exception. Overall, credit default rates continue to
trend lower. The result is good demand for preferred securities, little new
issuance, and tighter spreads. We think these factors will continue to benefit
the markets for some time to come.
Trading activity in the "retail" segment of the market(2) has been boosted
by the rapid growth of exchange traded funds. ETF's that invest primarily in
preferred securities are "rules based" in that there is limited discretion about
how a fund is managed--the objective is to closely track a specific index. We
sometimes scratch our heads as to the appeal of these funds, but they do provide
a healthy dose of liquidity, and they have attracted a lot of new investors to
the preferred market.
In the aftermath of the financial crisis, new legislation (much of which
has yet to be implemented) has resulted in wide ranging changes to the banking
industry. Since preferred securities issued by banks comprise over sixty percent
of the overall market, we watch this legislation with great interest. In the
topic which follows, we discuss the most relevant regulatory changes; here,
we'll focus on market impact.
One thing we know for sure--certain types of preferred securities will
eventually become obsolete. It is now clear that regulatory changes will
diminish the benefits of some securities to the banks that issued them, and as a
result, it is widely assumed many preferred securities will be retired at the
earliest practical opportunity. The prospects of issuer redemptions have
provided a boost to the market.
Of course, this wouldn't be the preferred market without a fair share of
hazards. In some cases, buried deep in the documentation of a security, there is
language which permits the issuer to exercise an early redemption, at par, if
certain events occur. Without such a provision, the issuer would either have to
pay a premium to call the issue, or may not be permitted to call it at all until
some future date. Such events, which seemed remote just a couple years ago, have
in fact occurred in response to changes in financial regulation.
Market participants appear to have adjusted expectations about early
redemption of NON-BANK preferred securities as well, though for different
reasons. Recall that companies choose to issue preferred securities in part
because it can improve the ratings on its debt, which in turn can reduce the
all-in cost of its capital (since preferred is ranked "junior" to debt, the debt
is viewed to be more secure). The major rating agencies have become less
inclined to look favorably on certain types of preferred securities, hence
non-bank issuers may also be inclined to retire certain preferred issues sooner
than expected. The redemption terms of these non-bank issues haven't changed,
but the market now perceives the likelihood of issuer redemption to be higher
and as a result, prices adjust to reflect the perception.
While it has become clear that certain types of preferred securities are
destined to become a footnote in financial textbooks, a viable replacement has
yet to emerge. A lot of smart people are hard at work to build a better
preferred, and we're optimistic they will succeed (though it may take a few
iterations). You can bet we will be involved!
----------
(2) In general, rules for ETF's that invest primarily in preferred securities
require the funds to invest only in securities listed on a national stock
exchange; such issues comprise roughly half of the preferred market.
5
All of this leads to one unavoidable conclusion: DURING THE NEXT FEW YEARS,
MARKET PARTICIPANTS, INCLUDING THE FUND, WILL NEED TO FIND REPLACEMENTS FOR A
SIGNIFICANT NUMBER OF HIGH YIELDING SECURITIES. At this juncture, of course, we
cannot tell how the Fund will weather this reinvestment risk.
UPDATE ON REGULATORY AND CAPITAL REFORM FOR BANKS
As we discussed in detail in the Fund's semiannual report from May 2010,
banks face significant new regulation and stiffer capital requirements. We will
quickly summarize the key features of bank regulatory reform from the Dodd-Frank
bill and bank capital requirements from the Basel Committee on Bank
Supervision--both from the perspective of preferred investors.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank)
makes significant changes to banks' operations and capital requirements. Most
importantly for preferred investors, it eliminates trust preferred securities
(TruPS) from Tier 1 capital for most banks the Funds would invest in. (Tier 1
capital is one of the primary measures of capital for a financial company; it
includes common equity, retained earnings, qualifying preferred capital, and
regulatory assets). The new rules phase in starting from 2013 through 2015. This
change in regulatory treatment for TruPS makes it likely that most, though not
all, TruPS will be called between 2013 and 2016, as banks replace those
instruments with qualifying forms of Tier 1 capital. As of this writing, roughly
23% of the Fund's portfolio is invested in trust preferred securities issued by
U.S. banks.
Along with changes made by lawmakers in the U.S., the Basel Committee on
Banking Supervision in recent months has released its Basel III framework on
bank capital. (This committee sets international banking standards that are
subsequently adopted by national regulators, including the U.S.). These new
rules will sharply increase the amount of common equity capital held by banks,
while leaving an important role for preferred securities.
Currently, banks must hold at least 2.5% of risk-weighted assets (RWA) in
the form of common equity. (The U.S. minimum is 4% common equity, and most banks
carry substantially more than the minimum.) When Basel III is fully phased in,
minimum common equity will rise to 4.5% of RWA. Coupled with some additionally
required "capital buffers," we suspect that U.S. banks typically will hold 8-10%
common equity and at least 10-12% Tier 1 capital, two to four percentage points
higher than before the financial crisis. That's a lot more common equity
providing credit support to preferred securities, which will comprise much of
the difference between total Tier 1 and Tier 1 common equity.
Another likely, but still undecided, feature of the Basel III rules is a
provision to impose "loss absorbency" on any non-common Tier 1 capital
instruments. The theory is that all Tier 1 capital should be able to absorb
losses on both a "gone concern" basis (i.e., in bankruptcy or receivership) AND
on a "going-concern" basis. Historically, preferred securities have provided
substantial loss absorbency upon failure of a firm, since all preferred claims
are subordinate to claims of depositors and senior creditors. However,
preferreds are--strictly by their contractual terms--only moderately loss
absorbing on a going concern basis, because the issuer can defer dividend
payments but not eliminate the preferred liability outright in times of strain.
The Basel Committee wants to give regulators the ability to either convert
preferreds to common stock or write off the preferred liability if they believe
the bank is no longer viable.
We have written a lengthy comment letter to the Basel Committee on loss
absorbency. Interested readers will find it on the Fund's website or at the
Basel Committee website at http://www.bis.org/publ/bcbs174/fac.pdf. Suffice to
say that we think the proposed loss absorption provision for bank preferreds is
unnecessary in the United States, and perhaps elsewhere. Nonetheless, if
regulators
6
insist on it, we think a properly designed mechanism to convert preferred into
common stock would be acceptable to preferred investors, while a write-off
mechanism would not. We await the Committee's decision on this sometime in 2011.
Overall, the new regulatory framework being imposed on banks by Dodd-Frank
and Basel III will force banks to hold more capital or take less risk, or both.
With respect to bank capital, regulators are requiring substantially more common
equity capital than before, while retaining a meaningful role for preferred
securities. These developments are broadly supportive for bank preferreds,
though they do increase regulatory risk. As the new rules get implemented over
the next several years, there will be numerous changes and opportunities
awaiting preferred investors.
THE FUND'S LEVERAGE
Leverage is an important part of the Fund's strategy to produce high
current income. Over time, the cost of leverage is typically lower than the
yield on the Fund's portfolio. The difference between what the Fund earns on its
investments and pays on the money it borrows increases the income available to
common shareholders. Over the past fiscal year, the Fund has paid an average
interest rate of 1.443% on its borrowed money. Given the much higher current
yields generated by the Fund's portfolio, this use of leverage had a meaningful
positive impact on the Fund's dividends to common shareholders.
In addition to economic considerations, there is a set of rules that govern
leverage (most importantly, the terms and conditions of the Fund's leverage
agreement with its lender, and all relevant securities laws). We take all of
these factors into consideration as we manage the leverage AND the assets of the
Fund.
There are two useful measures of how much leverage the Fund has in place.
The first is simply the total dollar amount of leverage. The other measure is
the ratio of the Fund's assets financed by that leverage (in other words, the
amount of leverage divided by total assets). The chart below presents both
measures of leverage over the past three years.
PFD LEVERAGE HISTORY
(PERFORMANCE GRAPH)
PFD LEVERAGE
DATE PERCENT
---------- --------
12/28/2007 38.3%
1/25/2008 37.4%
2/29/2008 37.5%
3/28/2008 40.8%
4/25/2008 40.6%
5/30/2008 40.5%
6/27/2008 42.3%
7/25/2008 44.8%
8/29/2008 44.8%
10/3/2008 52.6%
10/31/2008 50.0%
11/28/2008 46.4%
12/26/2008 45.6%
1/30/2009 46.0%
2/27/2009 45.2%
3/27/2009 44.8%
4/24/2009 42.5%
5/29/2009 37.0%
6/26/2009 35.4%
6/30/2009 35.5%
7/2/2009 35.4%
7/10/2009 35.1%
7/17/2009 35.3%
7/24/2009 35.2%
7/31/2009 33.9%
8/7/2009 33.2%
8/14/2009 32.8%
8/21/2009 33.2%
8/28/2009 32.6%
8/31/2009 32.5%
9/4/2009 33.3%
9/11/2009 32.9%
9/18/2009 33.4%
9/25/2009 33.3%
9/30/2009 33.3%
10/2/2009 33.2%
10/9/2009 33.1%
10/16/2009 32.8%
10/23/2009 33.3%
10/30/2009 33.3%
11/6/2009 33.5%
11/13/2009 33.2%
11/20/2009 33.2%
11/27/2009 33.1%
11/30/2009 33.1%
12/4/2009 33.0%
12/11/2009 32.8%
12/18/2009 32.4%
12/24/2009 32.4%
12/31/2009 32.0%
1/8/2010 31.6%
1/15/2010 31.2%
1/22/2010 31.5%
1/29/2010 31.6%
2/5/2010 33.3%
2/12/2010 33.4%
2/16/2010 33.4%
2/19/2010 33.4%
2/26/2010 33.1%
3/5/2010 32.8%
3/12/2010 33.2%
3/19/2010 33.3%
3/26/2010 33.1%
3/31/2010 33.0%
4/1/2010 32.9%
4/16/2010 33.3%
4/23/2010 33.3%
4/30/2010 33.5%
5/7/2010 34.5%
5/14/2010 34.2%
5/24/2010 35.1%
5/28/2010 35.0%
6/4/2010 34.9%
6/11/2010 34.8%
6/18/2010 34.6%
6/25/2010 34.7%
6/30/2010 34.6%
7/2/2010 34.7%
7/9/2010 34.4%
7/16/2010 34.0%
7/23/2010 33.9%
7/30/2010 33.6%
8/6/2010 33.2%
8/13/2010 33.1%
8/20/2010 33.0%
8/27/2010 33.0%
8/31/2010 32.9%
9/3/2010 32.9%
9/10/2010 32.7%
9/17/2010 32.4%
9/24/2010 32.4%
9/30/2010 32.3%
10/1/2010 32.2%
10/8/2010 32.0%
10/15/2010 32.2%
10/22/2010 32.2%
10/29/2010 31.9%
11/5/2010 31.8%
11/12/2010 31.9%
11/19/2010 32.0%
11/26/2010 32.2%
11/30/2010 32.2%
12/3/2010 32.3%
12/10/2010 32.3%
12/17/2010 33.3%
12/23/2010 33.7%
12/31/2010 33.3%
MONTH END MONEY MARKET LOAN AMOUNT
DATE PREFERRED STOCK DRAWN
---------- --------------- -----------
12/31/2007 80 0
1/31/2008 80 0
2/29/2008 80 0
3/31/2008 80 0
4/30/2008 80 0
5/31/2008 80 0
6/30/2008 80 0
7/31/2008 80 0
8/31/2008 80 0
9/30/2008 80 0
10/31/2008 70 0
11/30/2008 55 0
12/31/2008 55 0
1/31/2009 55 0
2/28/2009 45 0
3/31/2009 45 0
4/30/2009 45 0
5/31/2009 45 0
6/30/2009 45 0
7/31/2009 0 45
8/31/2009 0 45
9/30/2009 0 50
10/31/2009 0 52
11/30/2009 0 52
12/31/2009 0 52
1/31/2010 0 52
2/28/2010 0 56
3/31/2010 0 58
4/30/2010 0 61
5/31/2010 0 61
6/30/2010 0 61
7/31/2010 0 61
8/31/2010 0 61
9/30/2010 0 61
10/31/2010 0 61
11/30/2010 0 61
12/31/2010 0 64
7
When the leverage was comprised entirely of auction preferred stock, the
AMOUNT of leverage rarely changed. As a result, the PERCENTAGE of the Fund's
leverage to total net assets varied as the value the portfolio moved up or down.
As can be seen in the chart, the leverage percentage climbed steadily as the
financial crisis unfolded from 2007 through early 2009 and the value of the
Fund's investment portfolio fell.
As the leverage ratio rose to unsustainable levels, the Fund sold assets
and used the proceeds to reduce leverage. While this meant that monthly
distributions to shareholders had to be cut, it also served to reduce the NAV
and market price risk to the Fund's common shareholders.
With debt leverage, the Fund now has the ability to INCREASE the amount
borrowed by the Fund (within certain limits!). This is important because the
dramatic recovery in asset prices meant the Fund could comfortably borrow more
and use the money to purchase additional securities. Throughout 2010, the Fund
continued to increase its leverage balances. These increases, at very favorable
interest rates, allowed the Fund to increase its monthly dividend three times
since December 2009, for a total of 25% in cumulative increases.
The "right" percentage of leverage in a fund is never a simple matter to
determine. Type of borrowing, the cost of funds and market conditions all will
be factors to consider. At present, we are comfortable with the leverage
percentage used by the Fund, and we will consider increasing or decreasing the
amount of borrowing based on future market conditions. Of course, we
continuously monitor our leverage balances and try to use leverage in a manner
consistent with the Fund's objective.
MONTHLY DISTRIBUTIONS TO FUND SHAREHOLDERS
The Fund makes monthly distributions of income to shareholders consistent
with the objective of the Fund to provide high current income. The Fund is a
regulated investment company, and as such, there are a number of tax laws that
require the Fund to distribute almost all of its net investment income to
shareholders each year. If the Fund were to not satisfy the minimum distribution
requirements, it could risk its pass-through status and perhaps face financial
penalties.
Even though these rules are well-defined, we still believe that there is a
bit of art involved in setting dividend policy. One approach to distributions
would be for the Fund to simply pay out its net earnings each month. Because of
the uneven nature of the Fund's income and expenses, this would likely result in
distribution rates that would change every month. This approach has never seemed
terribly appealing to us.
We believe our shareholders are better served by a more stable level of
monthly distributions. In striving for more stability and to reflect the
inherent uncertainty in predicting future net earnings, in any particular month
the Fund may pay out less than the amount earned for the same month; in other
months the distribution may be comprised of current month's earnings PLUS income
from prior months.
The rules mentioned above also impose a specific time-frame on the
decisions about distributions, as they require true-up over each fiscal year. If
the Fund has excess income at the end of this annual period, the Fund must make
decisions that balance the goal of income stability and the requirements imposed
by law. The Fund has always met the legal distribution requirements, but many
times in the past the Fund has decided to not exceed the minimum requirements
with the intent of "carrying over" a bit of income to the next fiscal-year
period. Given that the minimum requirements are quite high, the carryover can
never be more than a modest amount (less than one-month's dividend). There is an
economic cost associated with this decision in the form of an excise tax on
portions of the undistributed amounts, but we believe this cost is minimal and
more than offset by the benefits of a more stable distribution rate over time.
Details on the amount of undistributed net investment income and the incurrence
of any related excise tax, if applicable, are available in the Notes to the
financial statements.
8
As mentioned above, we believe this is more art than science, but the goal
of high current income that is sustainable over a reasonable period of time
seems to us consistent with trying to maximize value over the long-run for
shareholders.
FEDERAL TAX ADVANTAGES OF 2010 CALENDAR YEAR DISTRIBUTIONS
In 2010, the Fund passed on a portion of its income to individuals in the
form of qualified dividend income or QDI. Under federal law, QDI is taxed at a
maximum 15% rate instead of an individual's ordinary income tax rate. As a
result of recent changes to the Internal Revenue Code, it is expected that this
favorable tax rate for QDI will continue through 2012.
In calendar year 2010, approximately 52% of distributions made by the Fund
was eligible for QDI treatment. For an individual in the 28% marginal tax
bracket, this means that the Fund's total distributions will only be taxed at a
blended 21.3% rate versus the 28% rate which would apply to distributions by a
fund containing traditional corporate bonds. This tax advantage means that, all
other things being equal, such an individual who held 100 shares of Common Stock
of the Fund for the calendar year would have had to receive approximately $111
in distributions from a traditional corporate bond fund to net the same
after-tax amount as the $101 distributions paid by the Fund.
For detailed information about the tax treatment of the particular
distributions received from the Fund, please see the Form 1099 you receive from
either the Fund or your broker.
Corporate shareholders also receive a federal tax benefit from the 20.8% of
distributions that were eligible for the inter-corporate, dividends received
deduction or DRD.
It is important to remember that the composition of the portfolio and the
income distributions can change from one year to the next, and that the QDI or
DRD portions of 2011's distributions may not be the same (or even similar) to
2010.
STATUS OF THE FUND'S HEDGING STRATEGY
The Fund suspended its interest rate hedging program as the financial
crisis intensified in the autumn of 2008. There were three principal reasons why
we suspended the program at the time. First, the relationship between preferred
securities' prices and the Fund's hedging instruments (Treasury bond futures,
interest rate swaps, and options on both) was turned on its head during the
financial crisis. Historically, preferred prices had tended to rise (fall) in
periods of falling (rising) long-term Treasury rates, but as the financial
crisis unfolded, the opposite occurred: preferred prices plunged while Treasury
and swap rates fell as investors sold risky assets and raced into Treasuries.
Hedging lost its effectiveness. Second, the cost of hedging rose dramatically as
the yield curve steepened and options prices rose sharply. Finally, preferred
securities became exceptionally cheap and were likely to offer high returns to
shareholders even if Treasury yields increased moderately. Add them up, and we
believed that hedging simply would not work under market conditions at the time.
Looking at the hedging strategy currently, we conclude that it remains too
early to reinstate the hedging program. Although some preferred securities are
starting to move in concert with the general level of long-term Treasury rates,
many are not. For the preferred market as a whole, correlations between
movements in prices of preferreds and the hedge instruments we use are
increasing. However, they are too unstable to convince us that portfolio hedging
would be reliably effective. Meanwhile, the cost of hedging is high, and
preferreds continue to be attractively priced. At some point we expect that
these circumstances will change. When they do, we will consider hedging again
and may implement hedges prior to being able to communicate such a change to
shareholders in our regular quarterly reporting.
9
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OVERVIEW
NOVEMBER 30, 2010 (UNAUDITED)
FUND STATISTICS
---------------
Net Asset Value $ 11.86
Market Price $ 12.03
Premium 1.43%
Yield on Market Price 8.88%
Common Stock Shares
Outstanding 10,759,270
MOODY'S RATINGS % OF NET ASSETS+
--------------- ----------------
A 6.1%
BBB 71.4%
BB 20.0%
Below "BB" 0.7%
Not Rated* 0.2%
Below Investment Grade** 15.9%
* Does not include net other assets and liabilities of 1.6%
** Below investment grade by both Moody's and S&P.
(PIE CHART)
INDUSTRY CATEGORIES % OF NET ASSETS+
------------------- ----------------
Banking 40%
Utilities 26%
Insurance 21%
Energy 7%
Financial Services 2%
Other 4%
TOP 10 HOLDINGS BY ISSUER % OF NET ASSETS+
------------------------- ----------------
Banco Santander 5.1%
Capital One Financial 4.1%
PNC Financial Services 4.0%
Wells Fargo 4.0%
Liberty Mutual Group 3.9%
Metlife 3.1%
Barclays Bank Plc 2.9%
Interstate Power & Light 2.9%
Enbridge Energy Partners 2.8%
HSBC Plc 2.7%
% OF NET ASSETS***+
-------------------
Holdings Generating Qualified Dividend Income (QDI) for
Individuals 40%
Holdings Generating Income Eligible for the Corporate
Dividends Received Deduction (DRD) 26%
*** This does not reflect year-end results or actual tax categorization of Fund
distributions. These percentages can, and do, change, perhaps
significantly, depending on market conditions. Investors should consult
their tax advisor regarding their personal situation. See accompanying
notes to financial statements for the tax characterization of 2010
distributions.
+ Net Assets include assets attributable to the use of leverage.
10
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
PREFERRED SECURITIES -- 96.0%
BANKING -- 40.3%
$ 2,750,000 Astoria Capital Trust I, 9.75% 11/01/29, Series B ........................................ $ 2,865,063(1)
355,000 Banco Santander, 10.50% Pfd., Series 10 .................................................. 9,651,562**(1)(2)
Bank of America Corporation:
7,500 8.625% Pfd. ........................................................................... 188,025*
48,700 6.70% Pfd. ............................................................................ 1,119,126*(1)
$ 500,000 BankAmerica Institutional, Series A, 8.07% 12/31/26, 144A**** ............................ 506,250
Barclays Bank PLC:
$ 3,250,000 6.278% ................................................................................ 2,860,000**(1)(2)
25,000 6.625% Pfd., Series 2 ................................................................. 582,000**(1)(2)
1,200 7.75% Pfd., Series 4 .................................................................. 30,528**(2)
75,000 8.125% Pfd., Series 5 ................................................................. 1,935,000**(1)(2)
58,500 BB&T Capital Trust VI, 9.60% Pfd. 08/01/64 ............................................... 1,635,660(1)
$ 1,500,000 BBVA International Preferred, 5.919% ..................................................... 1,208,865**(2)
$ 750,000 BNP Paribas, 7.195%, 144A**** ............................................................ 748,125**(2)
$ 4,500,000 Capital One Capital III, 7.686% 08/15/36 ................................................. 4,545,000(1)
$ 500,000 Capital One Capital V, 10.25% 08/15/39 ................................................... 531,875
$ 2,500,000 Capital One Capital VI, 8.875% 05/15/40 .................................................. 2,631,250(1)
62,300 Citigroup Capital XIII, 7.875% Pfd. 10/30/40 ............................................. 1,645,499
$ 5,210,000 Colonial BancGroup, 7.114%, 144A**** ..................................................... 131,813++
9,000 FBOP Corporation, Adj. Rate Pfd., 144A**** ............................................... 39,816*+(3)
$ 750,000 Fifth Third Capital Trust IV, 6.50% 04/15/37 ............................................. 703,125
15,000 Fifth Third Capital Trust V, 7.25% Pfd. 08/15/67 ......................................... 373,650
130,000 Fifth Third Capital Trust VI, 7.25% Pfd. 11/15/67 ........................................ 3,254,225(1)
14,500 Fifth Third Capital Trust VII, 8.875% Pfd. 05/15/68 ...................................... 375,188
1,250 First Republic Preferred Capital Corporation, 10.50% Pfd., 144A**** ...................... 1,291,250(1)
22,500 First Republic Preferred Capital Corporation II, 8.75% Pfd., Series B, 144A**** .......... 574,454(1)
3,750 First Tennessee Bank, Adj. Rate Pfd., 144A**** ........................................... 2,341,406*(1)
$ 600,000 First Tennessee Capital I, 8.07% 01/06/27, Series A ...................................... 566,732
$ 500,000 First Tennessee Capital II, 6.30% 04/15/34, Series B ..................................... 375,813
$ 1,500,000 First Union Capital II, 7.95% 11/15/29 ................................................... 1,635,079(1)
$ 1,000,000 First Union Institutional Capital I, 8.04% 12/01/26 ...................................... 1,024,800(1)
$ 500,000 Fleet Capital Trust II, 7.92% 12/11/26 ................................................... 505,000
Goldman Sachs:
$ 500,000 Capital I, 6.345% 02/15/34 ............................................................ 467,780(1)
$ 1,938,000 Capital II, 5.793% .................................................................... 1,647,300(1)
2,800 STRIPES Custodial Receipts, Pvt. ...................................................... 1,890,000*(3)
113,400 HSBC Holdings PLC, 8.00% Pfd., Series 2 .................................................. 3,065,349**(1)(2)
The accompanying notes are an integral part of the financial statements.
11
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
PREFERRED SECURITIES -- (CONTINUED)
BANKING -- (CONTINUED)
$ 500,000 HSBC USA Capital Trust II, 8.38% 05/15/27, 144A**** ...................................... $ 510,873
HSBC USA, Inc.:
42,000 6.50% Pfd., Series H .................................................................. 1,043,440*(1)
4,400 $2.8575 Pfd. .......................................................................... 209,688*(1)
$ 1,175,000 JPMorgan Chase Capital XVIII, 6.95% 08/17/36, Series R ................................... 1,182,025
15,000 Keycorp Capital VIII, 7.00% Pfd. 06/15/66 ................................................ 371,723(1)
72,000 Keycorp Capital IX, 6.75% Pfd. 12/15/66 .................................................. 1,792,188
27,600 Keycorp Capital X, 8.00% Pfd. 03/15/68 ................................................... 710,700(1)
$ 550,000 Lloyds Banking Group PLC, 6.657%, 144A**** ............................................... 371,250**(2)+
3,000 National City Capital Trust II, 6.625% Pfd. 11/15/36 ..................................... 75,038
$ 860,000 NB Capital Trust IV, 8.25% 04/15/27 ...................................................... 872,900(1)
200,000 PNC Financial Services, 9.875% Pfd., Series L ............................................ 5,581,260*(1)
$ 1,750,000 PNC Preferred Funding Trust III, 8.70%, 144A**** ......................................... 1,883,905(1)
1,750 Sovereign REIT, 12.00% Pfd., Series A, 144A**** .......................................... 1,999,375
$ 2,400,000 Wachovia Capital Trust III, 5.80% ........................................................ 2,040,000(1)
$ 1,200,000 Wachovia Capital Trust V, 7.965% 06/01/27, 144A**** ...................................... 1,211,636
$ 1,000,000 Washington Mutual, 9.75%, 144A**** ....................................................... 35,000++
$ 1,600,000 Webster Capital Trust IV, 7.65% 06/15/37 ................................................. 1,390,379(1)
15,000 Wells Fargo & Company, 8.00% Pfd., Series J .............................................. 400,950*
$ 1,000,000 Wells Fargo Capital XV, 9.75% ............................................................ 1,118,750(1)
-------------
75,747,688
-------------
FINANCIAL SERVICES -- 1.8%
33,000 Heller Financial, Inc., 6.687% Pfd., Series C ............................................ 3,177,283*(1)
10,300 HSBC Finance Corporation, 6.36% Pfd. ..................................................... 241,973*
Lehman Brothers Holdings, Inc.:
15,000 5.67% Pfd., Series D .................................................................. 4,125*++
19,500 5.94% Pfd., Series C .................................................................. 5,265*++
25,000 6.50% Pfd., Series F .................................................................. 1,812*++
27,500 7.95% Pfd. ............................................................................ 440*++
-------------
3,430,898
-------------
INSURANCE -- 19.0%
$ 975,000 Ace Capital Trust II, 9.70% 04/01/30 ..................................................... 1,190,010(1)(2)
$ 250,000 AON Corporation, 8.205% 01/01/27 ......................................................... 265,080
14,300 Arch Capital Group Ltd., 8.00% Pfd., Series A ............................................ 364,650**(1)(2)
The accompanying notes are an integral part of the financial statements.
12
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
PREFERRED SECURITIES -- (CONTINUED)
INSURANCE -- (CONTINUED)
AXA SA:
$ 1,750,000 6.379%, 144A**** ...................................................................... $ 1,627,500**(1)(2)
$ 2,250,000 6.463%, 144A**** ...................................................................... 2,070,000**(1)(2)
35,900 Axis Capital Holdings, 7.50% Pfd., Series B .............................................. 3,316,262(1)(2)
90,600 Delphi Financial Group, 7.376% Pfd. 05/15/37 ............................................. 2,120,611(1)
$ 4,000,000 Everest Re Holdings, 6.60% 05/15/37 ...................................................... 3,800,000(1)
$ 4,100,000 Liberty Mutual Group, 10.75% 06/15/58, 144A**** .......................................... 5,043,000(1)
$ 2,100,000 MetLife Capital Trust X, 9.25% 04/08/38, 144A**** ........................................ 2,493,750(1)
$ 2,400,000 MetLife, Inc., 10.75% 08/01/39 ........................................................... 3,242,345(1)
Principal Financial Group:
16,000 5.563% Pfd., Series A ................................................................. 1,469,000*(1)
62,500 6.518% Pfd., Series B ................................................................. 1,558,594*(1)
60,000 Renaissancere Holdings Ltd., 6.08% Pfd., Series C ........................................ 1,372,800**(1)(2)
119,500 Scottish Re Group Ltd., 7.25% Pfd. ....................................................... 1,023,219**(2)+
$ 1,300,000 Stancorp Financial Group, 6.90% 06/01/67 ................................................. 1,249,598(1)
$ 750,000 USF&G Capital, 8.312% 07/01/46, 144A**** ................................................. 819,303(1)
$ 2,000,000 XL Capital Ltd., 6.50%, Series E ......................................................... 1,725,000(1)(2)
$ 1,000,000 ZFS Finance USA Trust V, 6.50% 05/09/37, 144A**** ........................................ 977,500
-------------
35,728,222
-------------
UTILITIES -- 26.0%
10,000 Baltimore Gas & Electric Company, 6.70% Pfd., Series 1993 ................................ 996,250*(1)
20,600 Calenergy Capital Trust III, 6.50% Pfd. 09/01/27 ......................................... 1,022,790
$ 3,458,000 COMED Financing III, 6.35% 03/15/33 ...................................................... 3,003,626(1)
$ 250,000 Dominion Resources Capital Trust I, 7.83% 12/01/27 ....................................... 256,928
Dominion Resources, Inc.:
$ 3,500,000 7.50% 06/30/66 ........................................................................ 3,644,123(1)
22,500 8.375% Pfd. 06/15/64, Series A ........................................................ 659,250(1)
40,000 Entergy Arkansas, Inc., 6.45% Pfd. ....................................................... 986,252*(1)
20,000 Entergy Louisiana, Inc., 6.95% Pfd. ...................................................... 1,958,126*
$ 2,000,000 FPL Group Capital, Inc., 6.65% 06/15/67 .................................................. 1,977,578(1)
Georgia Power Company:
4,719 6.125% Pfd. ........................................................................... 121,809*
25,000 6.50% Pfd., Series 2007A .............................................................. 2,664,845*(1)
3,000 Gulf Power Company, 6.45% Pfd., Series 2007A ............................................. 312,909*(1)
32,650 Indianapolis Power & Light Company, 5.65% Pfd. ........................................... 3,066,041*
The accompanying notes are an integral part of the financial statements.
13
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
PREFERRED SECURITIES -- (CONTINUED)
UTILITIES -- (CONTINUED)
185,596 Interstate Power & Light Company, 8.375% Pfd., Series B .................................. $ 5,380,892*(1)
7,146 MDU Resources Group, 4.50% Pfd. 07/08/10 ................................................. 582,399*
22,430 Pacific Enterprises, $4.50 Pfd. .......................................................... 1,894,635*(1)
$ 500,000 PECO Energy Capital Trust III, 7.38% 04/06/28, Series D .................................. 485,726(1)
$ 4,400,000 Puget Sound Energy, Inc., 6.974% 06/01/67 ................................................ 4,319,269(1)
55,500 Scana Corporation, 7.70% Pfd. 01/30/65 ................................................... 1,531,800(1)
Southern California Edison:
32,100 6.00% Pfd., Series C .................................................................. 3,116,711*(1)
17,500 6.125% Pfd. ........................................................................... 1,743,438*
$ 1,985,000 Southern Union Company, 7.20% 11/01/66 ................................................... 1,826,200(1)
$ 750,000 TXU Electric Capital V, 8.175% 01/30/37 .................................................. 200,625(3)
$ 3,500,000 Wisconsin Energy Corporation, 6.25% 05/15/67 ............................................. 3,434,480(1)
$ 3,250,000 WPS Resources Corporation, 6.11% 12/01/66 ................................................ 3,156,387(1)
6,750 Xcel Energy, Inc., $4.08 Pfd., Series B .................................................. 526,365*
-------------
48,869,454
-------------
ENERGY -- 7.0%
$ 5,000,000 Enbridge Energy Partners LP, 8.05% 10/01/37 .............................................. 5,252,740(1)
Enterprise Products Partners:
$ 750,000 7.00% 06/01/67 ........................................................................ 738,478
$ 3,250,000 8.375% 08/01/66, Series A ............................................................. 3,457,015(1)
3,500 Kinder Morgan GP, Inc., 8.33% Pfd., 144A**** ............................................. 3,647,875*
-------------
13,096,108
-------------
REAL ESTATE INVESTMENT TRUST (REIT) -- 0.2%
12,500 PS Business Parks, Inc., 6.70% Pfd., Series P ............................................ 307,531
-------------
307,531
-------------
MISCELLANEOUS INDUSTRIES -- 1.7%
40,000 Ocean Spray Cranberries, Inc., 6.25% Pfd., 144A**** ...................................... 3,305,000*(1)
-------------
3,305,000
-------------
TOTAL PREFERRED SECURITIES
(Cost $175,334,896) ................................................................... 180,484,901
-------------
The accompanying notes are an integral part of the financial statements.
14
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
CORPORATE DEBT SECURITIES -- 2.5%
FINANCIAL SERVICES -- 0.2%
16,800 Goldman Sachs Group, 6.125% 11/01/60 ..................................................... $ 401,626
-------------
401,626
-------------
INSURANCE -- 2.3%
$ 2,500,000 Liberty Mutual Insurance, 7.697% 10/15/97, 144A**** ...................................... 2,270,282(1)
$ 2,000,000 UnumProvident Corporation, 7.25% 03/15/28 ................................................ 2,074,060(1)
-------------
4,344,342
-------------
TOTAL CORPORATE DEBT SECURITIES
(Cost $3,835,879) ..................................................................... 4,745,968
-------------
COMMON STOCK -- 0.1%
BANKING -- 0.1%
3,620 CIT Group, Inc. .......................................................................... 142,845*+
-------------
TOTAL COMMON STOCK
(Cost $330,325) ....................................................................... 142,845
-------------
MONEY MARKET FUND -- 0.4%
776,629 BlackRock Liquidity Funds, T-Fund ........................................................ 776,629
-------------
TOTAL MONEY MARKET FUND
(Cost $776,629) ....................................................................... 776,629
-------------
TOTAL INVESTMENTS (Cost $180,277,729***) ....................................................... 99.0% 186,150,343
OTHER ASSETS AND LIABILITIES (Net) ............................................................. 1.0% 1,910,780
----- -------------
NET ASSETS BEFORE LOAN ......................................................................... 100.0%+++ $ 188,061,123
----- -------------
LOAN PRINCIPAL BALANCE ................................................................................... (60,500,000)
-------------
TOTAL NET ASSETS AVAILABLE TO COMMON STOCK ............................................................... $ 127,561,123
=============
The accompanying notes are an integral part of the financial statements.
15
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2010
----------
* Securities eligible for the Dividends Received Deduction and distributing
Qualified Dividend Income.
** Securities distributing Qualified Dividend Income only.
*** Aggregate cost of securities held.
**** Securities exempt from registration under Rule 144A of the Securities Act
of 1933. These securities may be resold in transactions exempt from
registration to qualified institutional buyers. At November 30, 2010, these
securities amounted to $33,899,363 or 18.0% of net assets before loan.
(1) All or a portion of this security has been pledged as collateral for the
Fund's loan. The total value of such securities was $131,311,392 at
November 30, 2010.
(2) Foreign Issuer.
(3) Illiquid.
+ Non-income producing.
++ The issuer has filed for bankruptcy protection. As a result, the Fund may
not be able to recover the principal invested and also does not expect to
receive income on this security going forward.
+++ The percentage shown for each investment category is the total value of
that category as a percentage of net assets before the loan.
ABBREVIATIONS:
PFD. -- Preferred Securities
PVT. -- Private Placement Securities
REIT -- Real Estate Investment Trust
STRIPES -- Structured Residual Interest Preferred Enhanced Securities
The accompanying notes are an integral part of the financial statements.
16
Flaherty & Crumrine Preferred Income Fund Incorporated
STATEMENT OF ASSETS AND LIABILITIES
NOVEMBER 30, 2010
ASSETS:
Investments, at value (Cost $180,277,729) .................. $186,150,343
Receivable for investments sold ............................ 7,435
Dividends and interest receivable .......................... 2,419,016
Prepaid expenses ........................................... 59,238
------------
Total Assets ............................................ 188,636,032
LIABILITIES:
Loan Payable ............................................... $60,500,000
Payable for investments purchased .......................... 265,400
Dividends payable to Common Stock Shareholders ............. 100,989
Investment advisory fee payable ............................ 88,043
Administration, Transfer Agent and Custodian fees payable .. 28,359
Professional fees payable .................................. 62,481
Directors' fees payable .................................... 1,282
Accrued expenses and other payables ........................ 28,355
-----------
Total Liabilities ....................................... 61,074,909
------------
NET ASSETS AVAILABLE TO COMMON STOCK .......................... $127,561,123
============
NET ASSETS AVAILABLE TO COMMON STOCK consist of:
Undistributed net investment income ........................ $ 621,099
Accumulated net realized loss on investments sold .......... (32,176,053)
Unrealized appreciation of investments ..................... 5,872,614
Par value of Common Stock .................................. 107,593
Paid-in capital in excess of par value of Common Stock ..... 153,135,870
------------
Total Net Assets Available to Common Stock .............. $127,561,123
============
NET ASSET VALUE PER SHARE OF COMMON STOCK:
Common Stock (10,759,270 shares outstanding) ............... $ 11.86
============
The accompanying notes are an integral part of the financial statements.
17
Flaherty & Crumrine Preferred Income Fund Incorporated
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED NOVEMBER 30, 2010
INVESTMENT INCOME:
Dividends+ ................................................. $ 6,758,278
Interest ................................................... 7,463,708
-----------
Total Investment Income ................................. 14,221,986
EXPENSES:
Investment advisory fees ................................... $ 1,007,775
Administrator's fees ....................................... 183,630
Professional fees .......................................... 116,118
Insurance expenses ......................................... 112,051
Transfer Agent fees ........................................ 60,896
Directors' fees ............................................ 71,898
Custodian fees ............................................. 24,816
Compliance fees ............................................ 37,697
Interest expense ........................................... 854,382
Other ...................................................... 246,900
-----------
Total Expenses .......................................... 2,716,163
-----------
NET INVESTMENT INCOME ......................................... 11,505,823
-----------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
Net realized gain on investments sold during the year ...... 4,930,971
Change in net unrealized appreciation/depreciation of
investments ............................................. 15,769,549
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS ............... 20,700,520
-----------
DISTRIBUTIONS TO AUCTION PREFERRED STOCK SHAREHOLDERS:
From net investment income (including changes in accumulated
undeclared distributions) ............................... (70,977)
-----------
NET INCREASE IN NET ASSETS TO COMMON STOCK RESULTING
FROM OPERATIONS ............................................ $32,135,366
===========
----------
+ For Federal income tax purposes, a significant portion of this amount may
not qualify for the inter-corporate dividends received deduction ("DRD") or
as qualified dividend income ("QDI") for individuals.
The accompanying notes are an integral part of the financial statements.
18
Flaherty & Crumrine Preferred Income Fund Incorporated
STATEMENTS OF CHANGES IN NET ASSETS AVAILABLE TO COMMON STOCK
YEAR ENDED YEAR ENDED
NOVEMBER 30, 2010 NOVEMBER 30, 2009
----------------- -----------------
OPERATIONS:
Net investment income .............................................. $ 11,505,823 $ 9,734,389
Net realized gain/(loss) on investments sold during the year ....... 4,930,971 (15,921,276)
Change in net unrealized appreciation/depreciation of investments .. 15,769,549 56,189,433
Distributions to APS* Shareholders from net investment income,
including changes in accumulated undeclared distributions ....... (70,977) (1,041,660)
------------ ------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS ............... 32,135,366 48,960,886
DISTRIBUTIONS:
Dividends paid from net investment income to
Common Stock Shareholders(1) .................................... (10,325,246) (8,040,825)
------------ ------------
TOTAL DISTRIBUTIONS TO COMMON STOCK SHAREHOLDERS ................... (10,325,246) (8,040,825)
FUND SHARE TRANSACTIONS:
Increase from shares issued under the Dividend Reinvestment
and Cash Purchase Plan .......................................... 986,882 566,685
------------ ------------
NET INCREASE IN NET ASSETS AVAILABLE TO COMMON STOCK
RESULTING FROM FUND SHARE TRANSACTIONS .......................... 986,882 566,685
------------ ------------
NET INCREASE IN NET ASSETS AVAILABLE TO
COMMON STOCK FOR THE YEAR .......................................... $ 22,797,002 $ 41,486,746
============ ============
NET ASSETS AVAILABLE TO COMMON STOCK:
Beginning of year .................................................. $104,764,121 $ 63,277,375
Net increase in net assets during the year ......................... 22,797,002 41,486,746
------------ ------------
End of year (including undistributed net investment income
of $621,099 and $31,856, respectively) .......................... $127,561,123 $104,764,121
============ ============
----------
* Auction Preferred Stock.
(1) May include income earned, but not paid out, in prior fiscal year.
The accompanying notes are an integral part of the financial statements.
19
Flaherty & Crumrine Preferred Income Fund Incorporated
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED NOVEMBER 30, 2010
INCREASE/(DECREASE) IN CASH
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase in net assets resulting from operations ............... $ 32,135,366
ADJUSTMENTS TO RECONCILE NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Purchase of investment securities .................................. (73,762,167)
Proceeds from disposition of investment securities ................. 63,747,067
Sale of short-term investment securities, net ...................... (250,281)
Cash received from litigation claim ................................ 36,991
Increase in dividends and interest receivable ...................... (360,510)
Increase in receivable for investments sold ........................ (7,435)
Decrease in prepaid expenses ....................................... 165,450
Net amortization/(accretion) of premium/(discount) ................. (553,770)
Increase in payable for investments purchased ...................... 265,400
Increase in payables to related parties ............................ 13,616
Increase in accrued expenses and other liabilities ................. 2,163
Change in net unrealized appreciation/depreciation on securities ... (15,769,549)
Net realized gain from investments sold ............................ (4,930,971)
------------
Net cash provided by operating activities ....................... 731,370
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from loan ................................................. 8,700,000
Decrease in payable for APS ........................................ (132,290)
Dividends paid (net of reinvestment of dividends and change in
dividends payable) to common stock shareholders from net
investment income ............................................... (9,299,080)
------------
Net cash used by financing activities ........................... (731,370)
------------
Net increase/(decrease) in cash ................................. --
CASH:
Beginning of the year .............................................. --
------------
End of the year .................................................... $ --
============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid during the year ...................................... $ 857,675
Reinvestment of dividends .......................................... 986,882
Increase in dividends payable to common stock shareholders ......... 39,284
The accompanying notes are an integral part of the financial statements.
20
Flaherty & Crumrine Preferred Income Fund Incorporated
FINANCIAL HIGHLIGHTS
FOR A COMMON STOCK SHARE OUTSTANDING THROUGHOUT EACH YEAR.
Contained below is per share operating performance data, total investment
returns, ratios to average net assets and other supplemental data. This
information has been derived from information provided in the financial
statements and market price data for the Fund's shares.
YEAR ENDED NOVEMBER 30,
--------------------------------------------------
2010 2009 2008 2007 2006
-------- -------- -------- -------- --------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year ..................................... $ 9.82 $ 5.98 $ 12.85 $ 15.80 $ 15.26
-------- -------- -------- -------- --------
INVESTMENT OPERATIONS:
Net investment income .................................................. 1.07 0.92 1.27 1.35 1.29
Net realized and unrealized gain/(loss) on investments ................. 1.94 3.78 (6.80) (2.90) 0.62
DISTRIBUTIONS TO APS* SHAREHOLDERS:
From net investment income ............................................. (0.01) (0.10) (0.42) (0.37) (0.32)
-------- -------- -------- -------- --------
Total from investment operations ....................................... 3.00 4.60 (5.95) (1.92) 1.59
-------- -------- -------- -------- --------
DISTRIBUTIONS TO COMMON STOCK SHAREHOLDERS:
From net investment income ............................................. (0.96) (0.76) (0.87) (1.03) (1.05)
From return of capital ................................................. -- -- (0.05) -- --
-------- -------- -------- -------- --------
Total distributions to Common Stock Shareholders ....................... (0.96) (0.76) (0.92) (1.03) (1.05)
-------- -------- -------- -------- --------
Net asset value, end of year ........................................... $ 11.86 $ 9.82 $ 5.98 $ 12.85 $ 15.80
======== ======== ======== ======== ========
Market value, end of year .............................................. $ 12.03 $ 9.12 $ 5.67 $ 12.41 $ 16.98
Total investment return based on net asset value** ..................... 31.52% 82.53% (48.39%) (12.90%) 10.74%
Total investment return based on market value** ........................ 43.65% 78.78% (49.34%) (21.73%) 10.47%
RATIOS TO AVERAGE NET ASSETS AVAILABLE
TO COMMON STOCK SHAREHOLDERS:
Total net assets, end of year (in 000's) ............................ $127,561 $104,764 $ 63,277 $135,555 $165,475
Operating expenses including interest expense(1) .................... 2.29% 2.44% -- -- --
Operating expenses excluding interest expense ....................... 1.57% 2.04% 1.99% 1.49% 1.49%
Net investment income + ............................................. 9.72% 12.55% -- -- --
Net investment income, including payments to APS Shareholders + ..... 9.66% 11.21% 8.38% 6.57% 6.39%
SUPPLEMENTAL DATA: ++
Portfolio turnover rate ............................................. 37% 56% 67% 59% 71%
Net assets before loan, end of year (in 000's) ...................... $188,061 $156,564 $118,077 $215,555 $245,475
Ratio of operating expenses including interest expense(1)(2) to net
assets before loan and APS ....................................... 1.54% 1.50% -- -- --
Ratio of operating expenses excluding interest expense(2) to net
assets before loan and APS ....................................... 1.05% 1.25% 1.15% 0.99% 0.99%
----------
* Auction Preferred Stock.
** Assumes reinvestment of distributions at the price obtained by the Fund's
Dividend Reinvestment and Cash Purchase Plan.
+ The net investment income ratios reflect income net of operating expenses,
including interest expense.
++ Information presented under heading Supplemental Data includes APS and loan
principal balance.
(1) See Note 8.
(2) Does not include distributions to APS shareholders.
The accompanying notes are an integral part of the financial statements.
21
Flaherty & Crumrine Preferred Income Fund Incorporated
FINANCIAL HIGHLIGHTS (CONTINUED)
PER SHARE OF COMMON STOCK
TOTAL DIVIDEND
DIVIDENDS NET ASSET NYSE REINVESTMENT
PAID VALUE CLOSING PRICE PRICE (1)
--------- --------- ------------- ------------
December 31, 2009 ... $0.0720 $10.31 $10.47 $10.31
January 29, 2010 .... 0.0720 10.52 10.59 10.52
February 26, 2010 ... 0.0720 10.67 11.37 10.80
March 31, 2010 ...... 0.0720 11.08 11.32 11.08
April 30, 2010 ...... 0.0720 11.24 11.93 11.33
May 28, 2010 ........ 0.0825 10.48 10.67 10.48
June 30, 2010 ....... 0.0825 10.65 11.30 10.74
July 30, 2010 ....... 0.0825 11.15 12.33 11.71
August 31, 2010 ..... 0.0890 11.49 12.37 11.75
September 30, 2010 .. 0.0890 11.82 13.18 12.52
October 29, 2010 .... 0.0890 12.00 12.63 12.00
November 30, 2010 ... 0.0890 11.86 12.03 11.86
----------
(1) Whenever the net asset value per share of the Fund's Common Stock is less
than or equal to the market price per share on the reinvestment date, new
shares issued will be valued at the higher of net asset value or 95% of the
then current market price. Otherwise, the reinvestment shares of Common
Stock will be purchased in the open market.
The accompanying notes are an integral part of the financial statements.
22
Flaherty & Crumrine Preferred Income Fund Incorporated
FINANCIAL HIGHLIGHTS (CONTINUED)
SENIOR SECURITIES
INVOLUNTARY
ASSET LIQUIDATION TOTAL DEBT ASSET
COVERAGE PREFERENCE OUTSTANDING COVERAGE PER
TOTAL APS* SHARES PER APS PER APS END OF PERIOD $1,000 OF
DATE OUTSTANDING (1) SHARE (2) SHARE (3) (000S) (4) DEBT (5)
-------- ----------------- --------- ----------- ------------- ------------
11/30/10 -- N/A N/A $60,500 $3,108
11/30/09 -- N/A N/A 51,800 3,022
11/30/08 548 $216,717 $100,000 N/A N/A
11/30/07 800 270,586 100,000 N/A N/A
11/30/06 800 307,433 100,000 N/A N/A
----------
(1) See note 7.
(2) Calculated by subtracting the Fund's total liabilities (excluding the APS
and accumulated undeclared distributions to APS) from the Fund's total
assets and dividing that amount by the number of APS shares outstanding.
(3) Excludes accumulated undeclared dividends.
(4) See note 8.
(5) Calculated by subtracting the Fund's total liabilities (excluding the loan)
from the Fund's total assets and dividing that amount by the loan
outstanding in 000's.
* Auction Preferred Stock.
The accompanying notes are an integral part of the financial statements.
23
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Flaherty & Crumrine Preferred Income Fund Incorporated (the "Fund") was
incorporated as a Maryland corporation on September 28, 1990, and commenced
operations on January 31, 1991 as a diversified, closed-end management
investment company under the Investment Company Act of 1940, as amended (the
"1940 Act"). The Fund's investment objective is to provide its common
shareholders with high current income consistent with the preservation of
capital.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of the financial statements is in conformity with U.S. generally
accepted accounting principles ("US GAAP") and requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities in the financial statements and the reported amounts of increases
and decreases in net assets from operations during the reporting period. Actual
results could differ from those estimates.
PORTFOLIO VALUATION: The net asset value of the Fund's Common Stock is
determined by the Fund's Administrator no less frequently than on the last
business day of each week and month in accordance with the policies and
procedures approved by the Board of Directors of the Fund. It is determined by
dividing the value of the Fund's net assets available to Common Stock by the
number of shares of Common Stock outstanding. The value of the Fund's net assets
available to Common Stock is deemed to equal the value of the Fund's total
assets less (i) the Fund's liabilities and (ii) the aggregate liquidation value
of any outstanding preferred stock.
The Fund's preferred and debt securities are valued on the basis of current
market quotations provided by independent pricing services or dealers approved
by the Board of Directors of the Fund. Each quotation is based on the mean of
the bid and asked prices of a security. In determining the value of a particular
preferred or debt security, a pricing service or dealer may use information with
respect to transactions in such investments, quotations, market transactions in
comparable investments, various relationships observed in the market between
investments, and/or calculated yield measures based on valuation technology
commonly employed in the market for such investments. Common stocks that are
traded on stock exchanges are valued at the last sale price or official close
price on the exchange, as of the close of business on the day the securities are
being valued or, lacking any sales, at the last available mean price. Futures
contracts and option contracts on futures contracts are valued on the basis of
the settlement price for such contracts on the primary exchange on which they
trade. Investments in over-the-counter derivative instruments, such as interest
rate swaps and options thereon ("swaptions"), are valued using prices supplied
by a pricing service, or if such prices are unavailable, prices provided by a
single broker or dealer that is not the counterparty or, if no such prices are
available, at a price at which the counterparty to the contract would repurchase
the instrument or terminate the contract. Investments for which market
quotations are not readily available or for which management determines that the
prices are not reflective of current market conditions are valued at fair value
as determined in good faith by or under the direction of the Board of Directors
of the Fund, including reference to valuations of other securities which are
comparable in quality, maturity and type.
24
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Investments in money market instruments and all debt and preferred
securities which mature in 60 days or less are valued at amortized cost.
Investments in money market funds are valued at the net asset value of such
funds.
FAIR VALUE MEASUREMENT: The inputs and valuation techniques used to measure
fair value of the Fund's investments are summarized into three levels as
described in the hierarchy below:
- Level 1 - quoted prices in active markets for identical securities
- Level 2 - other significant observable inputs (including quoted prices
for similar securities, interest rates, prepayment speeds, credit
risk, etc.)
- Level 3 - significant unobservable inputs (including the Fund's own
assumptions in determining the fair value of investments)
The inputs or methodology used for valuing securities are not necessarily
an indication of the risk associated with investing in those securities.
Transfers in and out of levels are recognized at market value at the end of the
period. A summary of the inputs used to value the Fund's investments as of
November 30, 2010 is as follows:
LEVEL 2 LEVEL 3
TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
NOVEMBER 30, 2010 PRICE INPUTS INPUTS
----------------- ----------- ------------ ------------
Preferred Securities
Banking $ 75,747,688 $49,998,249 $ 25,709,623 $39,816
Financial Services 3,430,898 241,973 3,188,925 --
Insurance 35,728,222 12,175,969 23,552,253 --
Utilities 48,869,454 11,337,874 37,531,580 --
Energy 13,096,108 -- 13,096,108 --
Real Estate Investment Trust (REIT) 307,531 307,531 -- --
Miscellaneous Industries 3,305,000 -- 3,305,000 --
Corporate Debt Securities 4,745,968 401,626 4,344,342 --
Common Stock
Banking 142,845 142,845 -- --
Money Market Fund 776,629 776,629 -- --
------------ ----------- ------------ -------
Total Investments $186,150,343 $75,382,696 $110,727,831 $39,816
============ =========== ============ =======
The Fund did not have any significant transfers in and out of Level 1 and
Level 2 during the period.
The Fund's investments in Level 2 and Level 3 are based primarily on market
information, where available. This includes, but is not limited to, prices
provided by third-party providers, observable trading activity (including the
recency, depth, and consistency of such information with quoted levels), and the
depth and consistency of broker-quoted prices. In the event market information
is not directly available, comparable information may be observed for securities
that are similar in many respects to those being valued. The Fund
25
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
may employ an income approach for certain securities that also takes into
account credit risk, interest rate risk, and potential recovery prospects.
The following is a reconciliation of Level 3 investments for which
significant unobservable inputs were used to determine fair value:
PREFERRED SECURITIES
----------------------------
TOTAL INVESTMENTS BANKING
----------------- -------
BALANCE AS OF 11/30/09 ............................ $49,500 $49,500
Accrued discounts/premiums ........................ -- --
Realized gain/(loss) .............................. -- --
Change in unrealized appreciation/(depreciation) .. (9,684) (9,684)
Net purchases/(sales) ............................. -- --
Transfers in and/or out of Level 3 ................ -- --
------- -------
BALANCE AS OF 11/30/10 ............................ $39,816 $39,816
As of November 30, 2010, total change in unrealized gain/(loss) on Level 3
securities still held at period-end and included in the change in net assets was
$(9,684). Total unrealized gain/(loss) for all securities (including Level 1 and
Level 2) can be found on the accompanying Statement of Operations.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are
recorded as of the trade date. Realized gains and losses from securities sold
are recorded on the specific identified cost basis. Dividend income is recorded
on ex-dividend dates. Interest income is recorded on the accrual basis. The Fund
also amortizes premiums and accretes discounts on fixed income securities using
the effective yield method.
OPTIONS: Purchases of options are recorded as an investment, the value of
which is marked-to-market at each valuation date. When the Fund enters into a
closing sale transaction, the Fund will record a gain or loss depending on the
difference between the purchase and sale price.
When the Fund writes an option, an amount equal to the premium received by
the Fund is recorded as a liability, the value of which is marked-to-market at
each valuation date. When a written option expires, the Fund realizes a gain
equal to the amount of the premium originally received. When the Fund enters
into a closing purchase transaction, the Fund realizes a gain (or loss if the
cost of the closing purchase transaction exceeds the premium received when the
option was written) without regard to any unrealized gain or loss on the
underlying security, and the liability related to such option is eliminated.
When a call option is exercised, the Fund realizes a gain or loss from the sale
of the underlying security and the proceeds from such sale are increased by the
amount of the premium originally received. When a put option is exercised, the
amount of the premium originally received will reduce the cost of the security
which the Fund purchased upon exercise.
REPURCHASE AGREEMENTS: The Fund may engage in repurchase agreement
transactions. The Fund's investment adviser reviews and approves the eligibility
of the banks and dealers with which the Fund may enter into repurchase agreement
transactions. The value of the collateral underlying such transactions is at
least equal at all times to the total amount of the repurchase obligations,
including interest. The Fund maintains possession of the collateral through its
custodian and, in the event of counterparty default, the
26
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Fund has the right to use the collateral to offset losses incurred. There is the
possibility of loss to the Fund in the event the Fund is delayed or prevented
from exercising its rights to dispose of the collateral securities.
FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company by complying with the requirements under subchapter
M of the Internal Revenue Code of 1986, as amended, applicable to regulated
investment companies and intends to distribute substantially all of its taxable
net investment income to its shareholders. Therefore, no federal income tax
provision is required.
Management has analyzed the Fund's tax positions taken on Federal income
tax returns for all open tax years (November 30, 2010, 2009, 2008 and 2007), and
has concluded that no provision for federal income tax is required in the Fund's
financial statements. The Fund's major tax jurisdictions are federal and
California. The Fund's 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 departments
of revenue.
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS: The Fund expects to declare
dividends on a monthly basis to shareholders of Common Stock ("Shareholders").
Distributions to Shareholders are recorded on the ex-dividend date. Any net
realized short-term capital gains will be distributed to Shareholders at least
annually. Any net realized long-term capital gains may be distributed to
Shareholders at least annually or may be retained by the Fund as determined by
the Fund's Board of Directors. Capital gains retained by the Fund are subject to
tax at the capital gains corporate tax rate. Subject to the Fund qualifying as a
regulated investment company, any taxes paid by the Fund on such net realized
long-term capital gains may be used by the Fund's Shareholders as a credit
against their own tax liabilities. The Fund may pay distributions in excess of
the Fund's net investment company taxable income and this excess would be a
tax-free return of capital distributed from the Fund's assets.
Income and capital gain distributions are determined and characterized in
accordance with income tax regulations which may differ from US GAAP. These
differences are primarily due to (1) differing treatments of income and gains on
various investment securities held by the Fund, including timing differences,
(2) the attribution of expenses against certain components of taxable investment
income, and (3) federal regulations requiring proportionate allocation of income
and gains to all classes of shareholders.
Distributions from net realized gains for book purposes may include
short-term capital gains, which are included as ordinary income for tax
purposes, and may exclude amortization of premium on certain fixed income
securities, which are not reflected in ordinary income for tax purposes. The tax
character of distributions paid, including changes in accumulated undeclared
distributions to APS shareholders, during 2010 and 2009 was as follows:
DISTRIBUTIONS PAID IN FISCAL YEAR 2010 DISTRIBUTIONS PAID IN FISCAL YEAR 2009
-------------------------------------- --------------------------------------
ORDINARY LONG-TERM ORDINARY LONG-TERM
INCOME CAPITAL GAINS INCOME CAPITAL GAINS
----------- ------------- ---------- -------------
Common $10,325,246 $0 $8,040,825 $0
Preferred $ 70,977 $0 $1,041,660 $0
27
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
As of November 30, 2010, the components of distributable earnings (i.e.,
ordinary income and capital gain/loss) available to Common Stock Shareholders,
on a tax basis, were as follows:
UNDISTRIBUTED UNDISTRIBUTED NET UNREALIZED
CAPITAL (LOSS) CARRYFORWARD ORDINARY INCOME LONG-TERM GAIN APPRECIATION/(DEPRECIATION)
--------------------------- --------------- -------------- ---------------------------
$(32,375,398) $974,075 $0 $6,071,959
The composition of the Fund's $32,375,398 accumulated realized capital
losses was $16,447,249 and $15,928,149 incurred in 2008 and 2009, respectively.
These losses may be carried forward and offset against any future capital gains
through 2016 and 2017, respectively. During the year ended November 30, 2010,
the Fund utilized $778,250, $2,761,487 and $1,738,373 of capital losses expiring
in 2012, 2015 and 2016, respectively.
RECLASSIFICATION OF ACCOUNTS: During the year ended November 30, 2010,
reclassifications were made in the Fund's capital accounts to report these
balances on a tax basis, excluding temporary differences, as of November 30,
2010. Additional adjustments may be required in subsequent reporting periods.
These reclassifications have no impact on the net asset value of the Fund. The
calculation of net investment income per share in the financial highlights
excludes these adjustments. Below are the reclassifications:
PAID-IN UNDISTRIBUTED ACCUMULATED NET REALIZED
CAPITAL NET INVESTMENT INCOME GAIN ON INVESTMENTS
------- --------------------- ------------------------
$11,100 $(520,357) $509,257
EXCISE TAX: The Internal Revenue Code of 1986, as amended, imposes a 4%
nondeductible excise tax on the Fund to the extent the Fund does not distribute
by the end of any calendar year at least (1) 98% of the sum of its net
investment income for that year and its capital gains (both long-term and
short-term) for its fiscal year and (2) certain undistributed amounts from
previous years. The Fund is subject to a payment of an estimated $20,000 of
Federal excise taxes attributable to calendar year 2010. The Fund paid $13,975
of Federal excise taxes attributable to calendar year 2009 in March 2010.
ADDITIONAL ACCOUNTING STANDARDS: In January 2010, the Financial Accounting
Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2010-06,
"Improving Disclosures about Fair Value Measurements". ASU No. 2010-06 amends
FASB Accounting Standards Codification Topic 820, Fair Value Measurements and
Disclosures, to require additional disclosures regarding fair value
measurements. Certain disclosures required by ASU No. 2010-06 are effective for
interim and annual reporting periods beginning after December 15, 2009, and
other required disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. Management
has evaluated the impact and has incorporated the disclosures required by ASU
No. 2010-06 in its financial statement disclosures.
3. DERIVATIVE INSTRUMENTS
The Fund intends to use derivatives primarily to economically hedge against
risks in the portfolio, namely interest rate risk and credit risk. Historically
the Fund has used options on treasury futures contracts for the purpose of
economically hedging against a significant increase in long-term interest rates.
When the strategy
28
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
has been employed, the Fund would purchase put options on treasury futures
contracts that would increase in value if long-term interest rates increased
significantly, offsetting some of the related decline in portfolio asset values.
The Fund has also purchased and written call options on treasury futures
contracts to supplement the put option strategy and also to reduce the overall
cost of the interest rate hedge (by earning premiums from the net sale of call
options).
The Fund has the authority to use other derivatives for hedging or to
increase expected return, but has not employed any of these derivatives to-date
and does not anticipate broad use of these derivatives in the near future
(although this may change without advance notice). Other approved derivatives
strategies include: buying and selling credit default swaps, interest rate swaps
and options thereon (swaptions), and options on securities. Accounting policies
for specific derivatives, including the location of these items in the financial
statements, are included in Note 2 as appropriate. No assurance can be given
that such use of derivatives will achieve their desired purposes or, in the case
of hedging, will result in an overall reduction of risk to the Fund.
The Fund did not use any derivatives during the fiscal years ended November
30, 2009 and November 30, 2010.
OPTIONS ON FINANCIAL FUTURES CONTRACTS: When the interest rate hedging
strategy is employed, the Fund intends to use options on financial futures
contracts in much the same way as described above. The risk associated with
purchasing options, and therefore the maximum loss the Fund would incur, is
limited to the purchase price originally paid. The risk in writing a call option
is that the Fund may forego the opportunity for 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.
4. INVESTMENT ADVISORY FEE, ADMINISTRATION FEE, TRANSFER AGENT FEE, CUSTODIAN
FEE, DIRECTORS' FEES AND CHIEF COMPLIANCE OFFICER FEE
Flaherty & Crumrine Incorporated (the "Adviser") serves as the Fund's
investment adviser. The Fund pays the Adviser a monthly fee at an annual rate of
0.625% of the value of the Fund's average monthly total managed assets up to
$100 million and 0.50% of the Fund's average monthly total managed assets of
$100 million or more.
For purposes of calculating the fees payable to the Adviser, Administrator
and Custodian, the Fund's total managed assets means the total assets of the
Fund (including any assets attributable to the Fund's preferred stock that may
be outstanding or otherwise attributable to the use of leverage) minus the sum
of accrued liabilities (other than debt, if any, representing financial
leverage). For purposes of determining total managed assets, the liquidation
preference of any outstanding preferred shares issued by the Fund is not treated
as a liability.
BNY Mellon Investment Servicing (US) Inc. ("BNY Mellon") (formerly known as
PNC Global Investment Servicing (U.S.) Inc.) serves as the Fund's Administrator.
As Administrator, BNY Mellon calculates the net asset value of the Fund's shares
attributable to Common Stock and generally assists in all aspects of the Fund's
administration and operation. As compensation for BNY Mellon's services as
Administrator, the Fund pays BNY Mellon a monthly fee at an annual rate of 0.10%
of the first $200 million of the Fund's average
29
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
weekly total managed assets, 0.04% of the next $300 million of the Fund's
average weekly total managed assets, 0.03% of the next $500 million of the
Fund's average weekly total managed assets and 0.02% of the Fund's average
weekly total managed assets above $1 billion.
BNY Mellon also serves as the Fund's Common Stock dividend-paying agent and
registrar (Transfer Agent). As compensation for BNY Mellon's services, the Fund
pays BNY Mellon a fee at an annual rate of 0.02% of the first $150 million of
the Fund's average weekly net assets attributable to Common Stock, 0.0075% of
the next $350 million of the Fund's average weekly net assets attributable to
Common Stock, and 0.0025% of the Fund's average weekly net assets attributable
to Common Stock above $500 million, plus certain out of pocket expenses. For the
purpose of calculating such fee, the Fund's average weekly net assets
attributable to Common Stock are deemed to be the average weekly value of the
Fund's total assets minus the sum of the Fund's liabilities. For this
calculation, the Fund's liabilities are deemed to include the aggregate
liquidation preference of any outstanding preferred shares and the loan
principal balance.
PFPC Trust Company ("PFPC Trust"), a member of BNY Mellon, serves as the
Fund's Custodian. As compensation for PFPC Trust's services as custodian, the
Fund pays PFPC Trust a monthly fee at the annual rate of 0.01% of the first $200
million of the Fund's average weekly total managed assets, 0.008% of the next
$300 million of the Fund's average weekly total managed assets, 0.006% of the
next $500 million of the Fund's average weekly total managed assets and 0.005%
of the Fund's average weekly total managed assets above $1 billion.
The Fund currently pays each Director who is not a director, officer or
employee of the Adviser a fee of $9,000 per annum, plus $750 for each in-person
meeting of the Board of Directors or Audit Committee, $500 for each in-person
meeting of the Nominating Committee, and $250 for each telephone meeting. The
Audit Committee Chairman receives an additional annual fee of $3,000. The Fund
also reimburses all Directors for travel and out-of-pocket expenses incurred in
connection with such meetings.
The Fund currently pays the Adviser a fee of $37,500 per annum for Chief
Compliance Officer services and reimburses out-of-pocket expenses incurred in
connection with providing services in this role.
5. PURCHASES AND SALES OF SECURITIES
For the year ended November 30, 2010, the cost of purchases and proceeds
from sales of securities excluding short-term investments, aggregated
$73,762,167 and $63,747,067, respectively.
At November 30, 2010, the aggregate cost of securities for federal income
tax purposes was $180,078,384, the aggregate gross unrealized appreciation for
all securities in which there is an excess of value over tax cost was
$26,743,815 and the aggregate gross unrealized depreciation for all securities
in which there is an excess of tax cost over value was $20,671,856.
30
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. COMMON STOCK
At November 30, 2010, 240,000,000 shares of $0.01 par value Common Stock
were authorized.
Common Stock transactions were as follows:
YEAR ENDED YEAR ENDED
11/30/10 11/30/09
----------------- -----------------
SHARES AMOUNT SHARES AMOUNT
------ -------- ------ --------
Shares issued under the Dividend Reinvestment
and Cash Purchase Plan 87,985 $986,882 85,637 $566,685
------ -------- ------ --------
7. AUCTION PREFERRED STOCK (APS)
The Fund's Articles of Incorporation authorize the issuance of up to
10,000,000 shares of $0.01 par value preferred stock. Prior to July 14, 2009,
the Fund had preferred stock issued in the form of APS. The APS was senior to
the Common Stock and resulted in the financial leveraging of the Common Stock.
As of July 14, 2009, the Fund redeemed and cancelled the last remaining shares
of APS and does not currently have any issued and outstanding shares of
preferred stock. Although the APS was redeemed, certain additional distributions
were owed to previous holders and were paid in December, 2009.
The Fund redeemed APS shares as detailed in the table below. Shares were
redeemed at a redemption price equal to the liquidation preference of $100,000
per share, plus the amount of accumulated but unpaid dividends for each
redemption date, respectively. The Fund utilized proceeds from its debt facility
(See Note 8) for the last redemption. After these redemptions, borrowings from
its debt facility were the Fund's sole source of leverage.
REDEMPTION DATE $ AMOUNT OF APS
----------------- ---------------
November 12, 2008 $15,000,000*
November 12, 2008 8,100,000*
November 20, 2008 2,100,000*
April 7, 2009 10,000,000*
July 14, 2009 44,800,000
* Shares were redeemed on the dates reflected; however, from the Fund's
perspective, the November 12th ($8,100,000) and November 20th redemptions
were effective as of October 24, 2008, the November 12th ($15,000,000)
redemption was effective as of November 7, 2008 and the April 7th
redemption was effective as of February 24, 2009. In all cases, the earlier
effective date was due to the unconditional deposit of funds with the
paying agent.
8. COMMITTED FINANCING AGREEMENT
The Fund entered into a committed financing agreement ("Financing
Agreement") on June 26, 2009 which allowed the Fund to borrow up to an initial
limit of $44.8 million on a secured basis. The primary use of the initial
proceeds was to redeem the outstanding shares of APS (See Note 7), although the
Fund will use the borrowing facility in the normal course of business as
financial leverage. Such leveraging tends to magnify both the risks and
opportunities to Shareholders. The Financing Agreement has been amended from
time to time to allow for changes in the committed amount. As of November 30,
2010, the committed amount, and amount borrowed under the Financing Agreement
was $60.5 million.
31
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The lender charges an annualized rate of 1.00% on the undrawn (committed)
balance, and three-month LIBOR (reset quarterly) plus 1.10% on the drawn
(borrowed) balance. Effective January 1, 2011 (subsequent to the reporting
period), the interest rates charged by the lender will be reduced. The
annualized rate on the undrawn balance will be 0.80% and the rate on the drawn
balance will be three-month LIBOR (reset quarterly) plus 0.95%. For the year
ended November 30, 2010, the daily weighted average annualized interest rate on
the drawn balance was 1.443% and the average daily loan balance was $58,342,466.
The Fund paid the lender an arrangement fee (at the origination of the facility)
equal to 0.50% of the committed amount of $44.8 million. The arrangement fee was
amortized to expense over a period of approximately eighteen months. LIBOR rates
may vary in a manner unrelated to the income received on the Fund's assets,
which could have either a beneficial or detrimental impact on net investment
income and gains available to Shareholders.
The Fund is required to meet certain asset coverage requirements under the
Financing Agreement and under the 1940 Act. In accordance with the asset
coverage requirements, at least two-thirds of the Fund's assets are expected to
be pledged as collateral assuming the full committed amount is drawn. Securities
pledged as collateral are identified in the portfolio of investments. If the
Fund fails to meet these requirements, or maintain other financial covenants
required under the Financing Agreement, the Fund may be required to repay
immediately, in part or in full, the amount borrowed under the Financing
Agreement. Additionally, failure to meet the foregoing requirements or covenants
could restrict the Fund's ability to pay dividends to Shareholders and could
necessitate sales of portfolio securities at inopportune times. The Financing
Agreement has no stated maturity, but may be terminated by either party without
cause with six months' advance notice.
9. PORTFOLIO INVESTMENTS, CONCENTRATION AND INVESTMENT QUALITY
The Fund invests primarily in a diversified portfolio of preferred
securities. This includes traditional preferred stocks eligible for the
inter-corporate dividends received deduction ("DRD") and fully taxable preferred
securities. Under normal market conditions, at least 80% of the value of the
Fund's net assets will be invested in preferred securities. Also, under normal
market conditions, the Fund invests at least 25% of its assets in securities
issued by companies in the utilities industry and at least 25% of its total
assets in securities issued by companies in the banking industry. The Fund's
portfolio may therefore be subject to greater risk and market fluctuation than a
portfolio of securities representing a broader range of investment alternatives.
The Fund may invest up to 25% of its assets at the time of purchase in
securities rated below investment grade. These securities must be rated at least
either "Ba3" by Moody's Investors Service, Inc. or "BB-" by Standard & Poor's
or, if unrated, judged to be comparable in quality by the Adviser, in any case,
at the time of purchase. However, these securities must be issued by an issuer
having a class of senior debt rated investment grade outstanding.
The Fund may invest up to 15% of its assets in common stocks and, under
normal market conditions, up to 20% of its assets in debt securities. Certain of
its investments in hybrid, i.e., fully taxable, preferred securities will be
subject to the foregoing 20% limitation to the extent that, in the opinion of
the Adviser, such investments are deemed to be debt-like in key characteristics.
Typically, a security will not be considered
32
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
debt-like (a) if an issuer can defer payment of income for eighteen months or
more without triggering an event of default and (b) if such issue is a junior
and fully subordinated liability of an issuer or its ultimate guarantor.
In addition to foreign money market securities, the Fund may invest up to
30% of its total assets in the securities of companies organized or having their
principal place of business outside the United States. All foreign securities
held by the Fund will be denominated in U.S. dollars.
The Fund may employ certain investment techniques in accordance with its
fundamental investment policies. These may include the use of when-issued and
delayed delivery transactions. Securities purchased or sold on a when-issued or
delayed delivery basis may be settled within 45 days after the date of the
transaction. The Fund may also enter into transactions, in accordance with its
investment policies, involving short sales of securities and purchases of
securities on margin. Such transactions may expose the Fund to credit and market
valuation risk greater than that associated with regular trade settlement
procedures.
10. SECURITIES LENDING
The Fund may lend up to 15% of its total assets (including the value of the
loan collateral) to certain qualified brokers in order to earn additional
income. The Fund receives compensation in the form of fees or interest earned on
the investment of any cash collateral received. The Fund also continues to
receive interest and dividends on the securities loaned. The Fund receives
collateral in the form of cash or securities with a market value at least equal
to the market value of the securities on loan, including accrued interest. In
the event of default or bankruptcy by the borrower, the Fund could experience
delays and costs in recovering the loaned securities or in gaining access to the
collateral. The Fund has the right under the lending agreement to recover the
securities from the borrower on demand. As of November 30, 2010 there were no
securities on loan by the Fund.
11. SUBSEQUENT EVENTS
Management has evaluated the impact of all subsequent events on the Fund
through the date the financial statements were issued, and has determined that
there were no subsequent events requiring recognition or disclosure in the
financial statements.
33
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Flaherty & Crumrine Preferred Income Fund Incorporated
We have audited the accompanying statement of assets and liabilities of
Flaherty & Crumrine Preferred Income Fund Incorporated, including the portfolio
of investments, as of November 30, 2010, and the related statement of operations
for the year then ended, the statements of changes in net assets for each of the
years in the two-year period then ended, the statement of cash flows for the
year then ended, and the financial highlights for each of the years in the
five-year period then ended. These financial statements and financial highlights
are the responsibility of the Fund's management. Our responsibility is to
express an opinion on these financial statements and financial highlights based
on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. Our procedures included
confirmation of securities owned as of November 30, 2010 by correspondence with
the custodian and brokers, or by other appropriate auditing procedures where
replies from brokers were not received. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Flaherty & Crumrine Preferred Income Fund Incorporated as of November 30, 2010,
the results of its operations and its cash flows for the year then ended, the
changes in its net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year
period then ended, in conformity with U.S. generally accepted accounting
principles.
/s/ KPMG LLP
Boston, Massachusetts
January 24, 2011
34
Flaherty & Crumrine Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED)
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
Under the Fund's Dividend Reinvestment and Cash Purchase Plan (the "Plan"),
a shareholder whose Common Stock is registered in his or her own name will have
all distributions reinvested automatically by BNY Mellon as agent under the
Plan, unless the shareholder elects to receive cash. Distributions with respect
to shares registered in the name of a broker-dealer or other nominee (that is,
in "street name") may be reinvested by the broker or nominee in additional
shares under the Plan, but only if the service is provided by the broker or
nominee, unless the shareholder elects to receive distributions in cash. A
shareholder who holds Common Stock registered in the name of a broker or other
nominee may not be able to transfer the Common Stock to another broker or
nominee and continue to participate in the Plan. Investors who own Common Stock
registered in street name should consult their broker or nominee for details
regarding reinvestment.
The number of shares of Common Stock distributed to participants in the
Plan in lieu of a cash dividend is determined in the following manner. Whenever
the market price per share of the Fund's Common Stock is equal to or exceeds the
net asset value per share on the valuation date, participants in the Plan will
be issued new shares valued at the higher of net asset value or 95% of the then
current market value. Otherwise, BNY Mellon will buy shares of the Fund's Common
Stock in the open market, on the New York Stock Exchange ("NYSE") or elsewhere,
on or shortly after the payment date of the dividend or distribution and
continuing until the ex-dividend date of the Fund's next distribution to holders
of the Common Stock or until it has expended for such purchases all of the cash
that would otherwise be payable to the participants. The number of purchased
shares that will then be credited to the participants' accounts will be based on
the average per share purchase price of the shares so purchased, including
brokerage commissions. If BNY Mellon commences purchases in the open market and
the then current market price of the shares (plus any estimated brokerage
commissions) subsequently exceeds their net asset value most recently determined
before the completion of the purchases, BNY Mellon will attempt to terminate
purchases in the open market and cause the Fund to issue the remaining dividend
or distribution in shares. In this case, the number of shares received by the
participant will be based on the weighted average of prices paid for shares
purchased in the open market and the price at which the Fund issues the
remaining shares. These remaining shares will be issued by the Fund at the
higher of net asset value or 95% of the then current market value.
Plan participants are not subject to any charge for reinvesting dividends
or capital gains distributions. Each Plan participant will, however, bear a
proportionate share of brokerage commissions incurred with respect to BNY
Mellon's open market purchases in connection with the reinvestment of dividends
or capital gains distributions. For the year ended November 30, 2010, no
brokerage commissions were incurred.
The automatic reinvestment of dividends and capital gains distributions
will not relieve Plan participants of any income tax that may be payable on the
dividends or capital gains distributions. A participant in the Plan will be
treated for Federal income tax purposes as having received, on the dividend
payment date, a dividend or distribution in an amount equal to the cash that the
participant could have received instead of shares.
35
Flaherty & Crumrine Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
In addition to acquiring shares of Common Stock through the reinvestment of
cash dividends and distributions, a shareholder may invest any further amounts
from $100 to $3,000 semi-annually at the then current market price in shares
purchased through the Plan. Such semi-annual investments are subject to any
brokerage commission charges incurred by BNY Mellon under the Plan.
A shareholder whose Common Stock is registered in his or her own name may
terminate participation in the Plan at any time by notifying BNY Mellon in
writing, by completing the form on the back of the Plan account statement and
forwarding it to BNY Mellon, or by calling BNY Mellon directly. A termination
will be effective immediately if notice is received by BNY Mellon not less than
10 days before any dividend or distribution record date. Otherwise, the
termination will be effective, and only with respect to any subsequent dividends
or distributions, on the first day after the dividend or distribution has been
credited to the participant's account in additional shares of the Fund. Upon
termination and according to a participant's instructions, BNY Mellon will
either (a) issue certificates for the whole shares credited to the shareholder's
Plan account and a check representing any fractional shares or (b) sell the
shares in the market. Shareholders who hold Common Stock registered in the name
of a broker or other nominee should consult their broker or nominee to terminate
participation.
The Plan is described in more detail in the Fund's Plan brochure.
Information concerning the Plan may be obtained from BNY Mellon at
1-866-351-7446.
PROXY VOTING POLICIES AND PROXY VOTING RECORD ON FORM N-PX
The Fund files Form N-PX with its complete proxy voting record for the 12
months ended June 30th no later than August 31st of each year. The Fund filed
its latest Form N-PX with the Securities and Exchange Commission ("SEC") on
August 23, 2010. This filing, as well as the Fund's proxy voting policies and
procedures, are available (i) without charge, upon request, by calling the
Fund's transfer agent at 1-866-351-7446 and (ii) on the SEC's website at
www.sec.gov. In addition, the Fund's proxy voting policies and procedures are
available on the Fund's website at www.preferredincome.com.
PORTFOLIO SCHEDULE ON FORM N-Q
The Fund files a complete schedule of portfolio holdings with the SEC for
the first and third fiscal quarters on Form N-Q, the latest of which was filed
for the quarter ended August 31, 2010. The Fund's Form N-Q is available on the
SEC's website at www.sec.gov or may be viewed and obtained from the SEC's Public
Reference Room in Washington D.C. Information on the operation of the Public
Reference Section may be obtained by calling 1-800-SEC-0330.
PORTFOLIO MANAGEMENT TEAM
In managing the day-to-day operations of the Fund, the Adviser relies on
the expertise of its team of money management professionals, consisting of
Messrs. Crumrine, Ettinger, Stone and Chadwick. The professional backgrounds of
each member of the management team are included in the "Information about Fund
Directors and Officers" section of this report.
36
Flaherty & Crumrine Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
SUPPLEMENTARY TAX INFORMATION
Distributions to Common Stock Shareholders are characterized as follows for
purposes of Federal income taxes (as a percentage of total distributions):
INDIVIDUAL SHAREHOLDER CORPORATE SHAREHOLDER
---------------------- ---------------------
ORDINARY ORDINARY
QDI INCOME DRD INCOME
----- -------- ----- --------
Fiscal Year 2010 51.21% 48.79% 21.89% 78.11%
Calendar Year 2010 51.53% 48.47% 20.82% 79.18%
Qualified Dividend Income ("QDI") distributions are taxable at a maximum
15% personal tax rate.
INFORMATION ABOUT FUND DIRECTORS AND OFFICERS
The business and affairs of the Fund are managed under the direction of the
Fund's Board of Directors. Information pertaining to the Directors and officers
of the Fund is set forth below.
PRINCIPAL NUMBER OF FUNDS
TERM OF OFFICE OCCUPATION(S) IN FUND COMPLEX
NAME, ADDRESS, POSITION(S) AND LENGTH OF DURING PAST OVERSEEN OTHER DIRECTORSHIPS
AND AGE HELD WITH FUND TIME SERVED* FIVE YEARS BY DIRECTOR HELD BY DIRECTOR**
-------------------------- -------------- ------------------ ------------------------- --------------- ----------------------
NON-INTERESTED
DIRECTORS:
DAVID GALE Director Class I Director President of Delta 4
Delta Dividend Group, Inc. since Dividend Group, Inc.
220 Montgomery Street January 1997 (investments)
Suite 426
San Francisco, CA 94104
Age: 61
MORGAN GUST Director Class III Director Owner and operator of 4 CoBiz, Financial, Inc.
301 E. Colorado Boulevard since various entities engaged (financial services)
Suite 720 January 1991 in agriculture and real
Pasadena, CA 91101 estate; Former President
Age: 63 of Giant Industries, Inc.
(petroleum refining and
marketing) from March
2002 through June 2007
----------
* The Fund's Board of Directors is divided into three classes, each class
having a term of three years. Each year the term of office of one class
expires and the successor or successors elected to such class serve for a
three year term. The three year term for each class expires as follows:
CLASS I DIRECTORS - three year term expires at the Fund's 2011 Annual
Meeting of Shareholders; directors may continue in office until their
successors are duly elected and qualified.
CLASS II DIRECTORS - three year term expires at the Fund's 2012 Annual
Meeting of Shareholders; directors may continue in office until their
successors are duly elected and qualified.
CLASS III DIRECTOR - three year term expires at the Fund's 2013 Annual
Meeting of Shareholders; director may continue in office until his
successor is duly elected and qualified.
** Each Director also serves as a Director for Flaherty & Crumrine Preferred
Income Opportunity Fund, Flaherty & Crumrine/Claymore Preferred Securities
Income Fund, and Flaherty & Crumrine/Claymore Total Return Fund.
37
Flaherty & Crumrine Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
PRINCIPAL NUMBER OF FUNDS
TERM OF OFFICE OCCUPATION(S) IN FUND COMPLEX
NAME, ADDRESS, POSITION(S) AND LENGTH OF DURING PAST OVERSEEN OTHER DIRECTORSHIPS
AND AGE HELD WITH FUND TIME SERVED* FIVE YEARS BY DIRECTOR HELD BY DIRECTOR**
-------------------------- -------------- ------------------ ------------------------- --------------- ----------------------
NON-INTERESTED
DIRECTORS:
KAREN H. HOGAN+ Director Class I Director Active Committee Member 4
301 E. Colorado Boulevard since and Volunteer to several
Suite 720 April 2005 non-profit organizations;
Pasadena, CA 91101 from September 1985 to
Age: 49 January 1997, Senior Vice
President of Preferred
Stock Origination at
Lehman Brothers and
Previously, Vice
President of New Product
Development
ROBERT F. WULF Director Class II Director Financial Consultant; 4
P.O. Box 753 and Audit since Trustee, University of
Neskowin, OR 97149 Committee January 1991 Oregon Foundation;
Age: 73 Chairman Trustee, San Francisco
Theological Seminary
INTERESTED
DIRECTOR:
DONALD F. CRUMRINE+, ++ Director, Class II Director Chairman of the Board 4
301 E. Colorado Boulevard Chairman of since and Director of Flaherty
Suite 720 the Board and January 1991 & Crumrine Incorporated
Pasadena, CA 91101 Chief
Age: 63 Executive
Officer
----------
* The Fund's Board of Directors is divided into three classes, each class
having a term of three years. Each year the term of office of one class
expires and the successor or successors elected to such class serve for a
three year term. The three year term for each class expires as follows:
CLASS I DIRECTORS - three year term expires at the Fund's 2011 Annual
Meeting of Shareholders; directors may continue in office until their
successors are duly elected and qualified.
CLASS II DIRECTORS - three year term expires at the Fund's 2012 Annual
Meeting of Shareholders; directors may continue in office until their
successors are duly elected and qualified.
CLASS III DIRECTOR - three year term expires at the Fund's 2013 Annual
Meeting of Shareholders; director may continue in office until his
successor is duly elected and qualified.
** Each Director also serves as a Director for Flaherty & Crumrine Preferred
Income Opportunity Fund, Flaherty & Crumrine/Claymore Preferred Securities
Income Fund, and Flaherty & Crumrine/Claymore Total Return Fund.
+ As a Director, until July 14, 2009, represented holders of shares of the
Fund's Auction Preferred Stock.
++ "Interested person" of the Fund as defined in the 1940 Act. Mr. Crumrine is
considered an "interested person" because of his affiliation with Flaherty
& Crumrine Incorporated, which acts as the Fund's investment adviser.
38
Flaherty & Crumrine Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
PRINCIPAL
TERM OF OFFICE OCCUPATION(S)
NAME, ADDRESS, POSITION(S) AND LENGTH OF DURING PAST
AND AGE HELD WITH FUND TIME SERVED FIVE YEARS
------------------------- ------------------- -------------- ------------------------------------
OFFICERS
ROBERT M. ETTINGER President Since President and Director of Flaherty &
301 E. Colorado Boulevard October 2002 Crumrine Incorporated
Suite 720
Pasadena, CA 91101
Age: 52
R. ERIC CHADWICK Chief Financial Since Director of Flaherty & Crumrine
301 E. Colorado Boulevard Officer, Vice July 2004 Incorporated since June 2006;
Suite 720 President and Vice President of Flaherty &
Pasadena, CA 91101 Treasurer Crumrine Incorporated
Age: 35
CHAD C. CONWELL Chief Compliance Since Chief Compliance Officer of
301 E. Colorado Boulevard Officer, Vice July 2005 Flaherty & Crumrine Incorporated
Suite 720 President and since September 2005; Vice
Pasadena, CA 91101 Secretary President of Flaherty & Crumrine
Age: 38 Incorporated since July 2005
BRADFORD S. STONE Vice President Since Director of Flaherty & Crumrine
47 Maple Street and Assistant July 2003 Incorporated since June 2006;
Suite 403 Treasurer Vice President of Flaherty &
Summit, NJ 07901 Crumrine Incorporated
Age: 51
LAURIE C. LODOLO Assistant Since Assistant Compliance Officer and
301 E. Colorado Boulevard Compliance July 2004 Secretary of Flaherty & Crumrine
Suite 720 Officer, Assistant Incorporated
Pasadena, CA 91101 Treasurer and
Age: 47 Assistant Secretary
LINDA M. PUCHALSKI Assistant Since Administrator of Flaherty & Crumrine
301 E. Colorado Boulevard Treasurer August 2010 Incorporated
Suite 720
Pasadena, CA 91101
Age: 54
39
DIRECTORS
Donald F. Crumrine, CFA
Chairman of the Board
David Gale
Morgan Gust
Karen H. Hogan
Robert F. Wulf, CFA
OFFICERS
Donald F. Crumrine, CFA
Chief Executive Officer
Robert M. Ettinger, CFA
President
R. Eric Chadwick, CFA
Chief Financial Officer,
Vice President and Treasurer
Chad C. Conwell
Chief Compliance Officer,
Vice President and Secretary
Bradford S. Stone
Vice President and
Assistant Treasurer
Laurie C. Lodolo
Assistant Compliance Officer,
Assistant Treasurer and
Assistant Secretary
Linda M. Puchalski
Assistant Treasurer
INVESTMENT ADVISER
Flaherty & Crumrine Incorporated
e-mail: flaherty@pfdincome.com
QUESTIONS CONCERNING YOUR SHARES OF FLAHERTY & CRUMRINE PREFERRED INCOME FUND?
- If your shares are held in a Brokerage Account, contact your Broker.
- If you have physical possession of your shares in certificate form,
contact the Fund's Transfer Agent & Shareholder Servicing Agent --
BNY Mellon Shareowner Services
P.O. Box 358035
Pittsburgh, PA 15252-8035
1-866-351-7446
THIS REPORT IS SENT TO SHAREHOLDERS OF FLAHERTY & CRUMRINE PREFERRED INCOME FUND
INCORPORATED FOR THEIR INFORMATION. IT IS NOT A PROSPECTUS, CIRCULAR OR
REPRESENTATION INTENDED FOR USE IN THE PURCHASE OR SALE OF SHARES OF THE FUND OR
OF ANY SECURITIES MENTIONED IN THIS REPORT.
(FLAHERTY & CRUMRINE PREFERRED INCOME FUND LOGO)
Annual
Report
November 30, 2010
www.preferredincome.com
ITEM 2. CODE OF ETHICS.
(a) The registrant, as of the end of the period covered by this report,
has adopted a code of ethics that applies to the registrant's
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions, regardless of whether these individuals are employed by the
registrant or a third party.
(c) There have been no amendments, during the period covered by this
report, to a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are
employed by the registrant or a third party, and that relates to any
element of the code of ethics description.
(d) The registrant has not granted any waivers, including an implicit
waiver, from a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are
employed by the registrant or a third party, that relates to one or
more of the items set forth in paragraph (b) of this item's
instructions.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
As of the end of the period covered by the report, the registrant's board of
directors has determined that David Gale, Karen H. Hogan and Robert F. Wulf are
each qualified to serve as an audit committee financial expert serving on its
audit committee and that they all are "independent," as defined by the
Securities and Exchange Commission.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
AUDIT FEES
(a) The aggregate fees billed for each of the last two fiscal years for
professional services rendered by the principal accountant for the
audit of the registrant's annual financial statements or services that
are normally provided by the accountant in connection with statutory
and regulatory filings or engagements for those fiscal years are
$44,000 for 2010 and $44,000 for 2009.
AUDIT-RELATED FEES
(b) The aggregate fees billed in each of the last two fiscal years for
assurance and related services by the principal accountant that are
reasonably related to the performance of the audit of the
registrant's financial statements and are not reported under paragraph
(a) of this Item are $0 for 2010 and $0 for 2009.
TAX FEES
(c) The aggregate fees billed in each of the last two fiscal years for
professional services rendered by the principal accountant for tax
compliance, tax advice, and tax planning are $8,100 for 2010 and
$8,100 for 2009.
ALL OTHER FEES
(d) The aggregate fees billed in each of the last two fiscal years for
products and services provided by the principal accountant, other than
the services reported in paragraphs (a) through (c) of this Item are
$0 for 2010 and $8,600 for 2009. These services consist of the
principal accountant providing a "Quarterly Agreed-Upon-Procedures
Report on Articles Supplementary". These Agreed-Upon-Procedures
("AUP") are requirements arising from the Articles Supplementary
creating the Fund's preferred stock. Specifically, the credit rating
agencies require such AUP be undertaken in order to maintain the
preferred stock's rating.
(e)(1) The Fund's Audit Committee Charter states that the Audit Committee
shall have the duty and power to pre-approve all audit and non-audit
services to be provided by the auditors to the Fund, and all non-audit
services to be provided by the auditors to the Fund's investment
adviser and any service providers controlling, controlled by or under
common control with the Fund's investment adviser that provide ongoing
services to the Fund, if the engagement relates directly to the
operations and financial reporting of the Fund.
(e)(2) The percentage of services described in each of paragraphs (b)
through (d) of this Item that were approved by the audit committee
pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X are
as follows:
(b) 0%
(c) 0%
(d) 0%
(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most
recent fiscal year that were attributed to work performed by persons
other than the principal accountant's full-time, permanent employees
was 0%.
(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's
investment adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or overseen
by another investment adviser), and any entity controlling, controlled
by, or under common control with the adviser that provides ongoing
services to the registrant for each of the last two fiscal years of
the registrant was $0 for 2010 and $0 for 2009.
(h) Not applicable.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
(a) The registrant has a separately designated audit committee consisting of
all the independent directors of the registrant. The members of the audit
committee are: David Gale, Morgan Gust, Karen H. Hogan, and Robert F. Wulf.
ITEM 6. INVESTMENTS.
(a) Schedule of Investments in securities of unaffiliated issuers as of the
close of the reporting period is included as part of the report to
shareholders filed under Item 1 of this form.
(b) Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Proxy Voting Policies are attached herewith.
ADVISER PROXY VOTING POLICIES AND PROCEDURES
Flaherty & Crumrine Incorporated ("F&C") acts as discretionary investment
adviser for various clients, including the following six pooled investment
vehicles (the "Funds"):
As adviser to the "U.S. Funds" Flaherty & Crumrine Preferred Income Fund
Flaherty & Crumrine Preferred Income
Opportunity Fund
Flaherty & Crumrine/Claymore Preferred
Securities Income Fund
Flaherty & Crumrine/Claymore Total Return Fund
As sub-adviser
to the "Canadian Fund" Flaherty & Crumrine Investment Grade Fixed
Income Fund
F&C's authority to vote proxies for its clients is established through the
delegation of discretionary authority under its investment advisory contracts
and the U.S. Funds have adopted these policies and procedures for themselves
PURPOSE
These policies and procedures are designed to satisfy F&C's duties of care and
loyalty to its clients with respect to monitoring corporate events and
exercising proxy authority in the best interests of such clients.
In connection with this objective, these policies and procedures are designed to
deal with potential complexities which may arise in cases where F&C's interests
conflict or appear to conflict with the interests of its clients.
These policies and procedures are also designed to communicate with clients the
methods and rationale whereby F&C exercises proxy voting authority.
This document is available to any client or Fund shareholder upon request and
F&C will make available to such clients and Fund shareholders the record of
F&C's votes promptly upon request and to the extent required by Federal law and
regulations.
FUNDAMENTAL STANDARD
F&C will be guided by the principle that, in those cases where it has proxy
voting authority, it will vote proxies, and take such other corporate actions,
consistent with the interest of its clients in a manner free of conflicts of
interest with the objective of client wealth maximization.
GENERAL
F&C has divided its discussion in this document into two major categories:
voting with respect to common stock and voting with respect to senior equity,
e.g., preferred stock and similar securities. In those events where F&C may have
to take action with respect to debt, such as in the case of amendments of
covenants or in the case of default, bankruptcy, reorganization, etc., F&C will
apply the same principles as would apply to common or preferred stock, MUTATIS
MUTANDIS.
These policies and procedures apply only where the client has granted
discretionary authority with respect to proxy voting. Where F&C does not have
authority, it will keep appropriate written records evidencing that such
discretionary authority has not been granted.
F&C may choose not to keep written copies of proxy materials that are subject to
SEC regulation and maintained in the SEC's EDGAR database. In other instances,
F&C will keep appropriate written records in its files or in reasonably
accessible storage.
Similarly, F&C will keep in its files, or reasonably accessible storage, work
papers and other materials that were significant to F&C in making a decision how
to vote.
For purposes of decision making, F&C will assume that each ballot for which it
casts votes is the only security of an issuer held by the client. Thus, when
casting votes where F&C may have discretionary authority with regard to several
different securities of the same issuer, it may vote securities "in favor" for
those securities or classes where F&C has determined the matter in question to
be beneficial while, at the same time, voting "against" for those securities or
classes where F&C has determined the matter to be adverse. Such cases
occasionally arise, for example, in those instances where a vote is required by
both common and preferred shareholders, voting as separate classes, for a change
in the terms regarding preferred stock issuance.
F&C will reach its voting decisions independently, after appropriate
investigation. It does not generally intend to delegate its decision making or
to rely on the recommendations of any third party, although it may take such
recommendations into consideration. F&C may consult with such other experts,
such as CPA's, investment bankers, attorneys, etc., as it regards necessary to
help it reach informed decisions.
Absent good reason to the contrary, F&C will generally give substantial weight
to management recommendations regarding voting. This is based on the view that
management is usually in the best position to know which corporate actions are
in the best interests of common shareholders as a whole.
With regard to those shareholder-originated proposals which are typically
described as "social, environmental, and corporate responsibility" matters, F&C
will typically give weight to management's recommendations and vote against such
shareholder proposals, particularly if the adoption of such proposals would
bring about burdens or costs not borne by those of the issuer's competitors.
In cases where the voting of proxies would not justify the time and costs
involved, F&C may refrain from voting. From the individual client's perspective,
this would most typically come about in the case of small holdings, such as
might arise in connection with spin-offs or other corporate reorganizations.
From the perspective of F&C's institutional clients, this envisions cases (1) as
more fully described below where preferred and common shareholders vote together
as a class or (2) other similar or analogous instances.
Ultimately, all voting decisions are made on a case-by-case basis, taking
relevant considerations into account.
VOTING OF COMMON STOCK PROXIES
F&C categorizes matters as either routine or non-routine, which definition may
or may not precisely conform to the definitions set forth by securities
exchanges or other bodies categorizing such matters. Routine matters would
include such things as the voting for directors and the ratification of auditors
and most shareholder proposals regarding social, environmental, and corporate
responsibility matters. Absent good reason to the contrary, F&C normally will
vote in favor of management's recommendations on these routine matters.
Non-routine matters might include, without limitation, such things as (1)
amendments to management incentive plans, (2) the authorization of additional
common or preferred stock, (3) initiation or termination of barriers to takeover
or acquisition, (4) mergers or acquisitions, (5) changes in the state of
incorporation, (6) corporate reorganizations, and (7) "contested" director
slates. In non-routine matters, F&C, as a matter of policy, will attempt to be
generally familiar with the questions at issue. This will include, without
limitation, studying news in the popular press, regulatory filings, and
competing proxy solicitation materials, if any. Non-routine matters will be
voted on a case-by-case basis, given the complexity of many of these issues.
VOTING OF PREFERRED STOCK PROXIES
Preferred stock, which is defined to include any form of equity senior to common
stock, generally has voting rights only in the event that the issuer has not
made timely payments of income and principal to shareholders or in the event
that a corporation desires to effectuate some change in its articles of
incorporation which might modify the rights of preferred stockholders. These are
non-routine in both form and substance.
In the case of non-routine matters having to do with the modification of the
rights or protections accorded preferred stock shareholders, F&C will attempt,
wherever possible, to assess the costs and benefits of such modifications and
will vote in favor of such modifications only if they are in the bests interests
of preferred shareholders or if the issuer has offered sufficient compensation
to preferred stock shareholders to offset the reasonably foreseeable adverse
consequences of such modifications. A similar type of analysis would be made in
the case where preferred shares, as a class, are entitled to vote on a merger or
other substantial transaction.
In the case of the election of directors when timely payments to preferred
shareholders have not been made ("contingent voting"), F&C will cast its votes
on a case-by-case basis after investigation of the qualifications and
independence of the persons standing for election.
Routine matters regarding preferred stock are the exception, rather than the
rule, and typically arise when the preferred and common shareholders vote
together as a class on such matters as election of directors. F&C will vote on a
case-by-case basis, reflecting the principles set forth elsewhere in this
document. However, in those instances (1) where the common shares of an issuer
are held by a parent company and (2) where, because of that, the election
outcome is not in doubt, F&C does not intend to vote such proxies since the time
and costs would outweigh the benefits.
ACTUAL AND APPARENT CONFLICTS OF INTEREST
Potential conflicts of interest between F&C and F&C's clients may arise when
F&C's relationships with an issuer or with a related third party conflict or
appear to conflict with the best interests of F&C's clients.
F&C will indicate in its voting records available to clients whether or not a
material conflict exists or appears to exist. In addition, F&C will communicate
with the client (which means the independent Directors or Director(s) they may
so designate in the case of the U.S. Funds and the investment adviser in the
case of the Canadian Funds) in instances when a material conflict of interest
may be apparent. F&C must describe the conflict to the client and state F&C's
voting recommendation and the basis therefor. If the client considers there to
be a reasonable basis for the proposed vote notwithstanding the conflict or, in
the case of the Funds, that the recommendation was not affected by the conflict
(without considering the merits of the proposal), F&C will vote in accordance
with the recommendation it had made to the client.
In all such instances, F&C will keep reasonable documentation supporting its
voting decisions and/or recommendations to clients.
AMENDMENT OF THE POLICIES AND PROCEDURES
These policies and procedures may be modified at any time by action of the Board
of Directors of F&C but will not become effective, in the case of the U.S.
Funds, unless they are approved by majority vote of the non-interested directors
of the U.S. Funds. Any such modifications will be sent to F&C's clients by mail
and/or other electronic means in a timely manner. These policies and procedures,
and any amendments hereto, will be posted on the U.S. Funds' websites and will
be disclosed in reports to shareholders as required by law.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
The following paragraphs provide certain information with respect to the
portfolio managers of the Fund and the material conflicts of interest that may
arise in connection with their management of the investments of the Fund, on the
one hand, and the investments of other client accounts for which they have
responsibility, on the other hand. Certain other potential conflicts of interest
with respect to personal trading and proxy voting are discussed above under
"Item 2 - Codes of Ethics" and "Item 7 - Proxy Voting Policies."
(A)(1) PORTFOLIO MANAGERS
R. Eric Chadwick, Donald F. Crumrine, Robert M. Ettinger and Bradford S. Stone
jointly serve as the Portfolio Managers of the Fund. Additional biographical
information about the portfolio managers is available in the Annual Report
included in Response to Item 1 above.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS
The tables below illustrate other accounts where each of the above-mentioned
four portfolio managers has significant day-to-day management responsibilities
as of November 30, 2010:
# of Accounts
Managed for which
Total Advisory Fee is
Name of Portfolio Manager # of Accounts Total Assets Based on
or Team Member TYPE OF ACCOUNTS Managed (mm) Performance
------------------------- -------------------------------------- ------------- ------------ -----------------
1. Donald F. Crumrine Other Registered Investment Companies: 3 1,430 0
Other Pooled Investment Vehicles: 1 194 0
Other Accounts: 12 2,155 0
2. Robert M. Ettinger Other Registered Investment Companies: 3 1,430 0
Other Pooled Investment Vehicles: 1 194 0
Other Accounts: 12 2,155 0
3. R. Eric Chadwick Other Registered Investment Companies: 3 1,430 0
Other Pooled Investment Vehicles: 1 194 0
Other Accounts: 12 2,155 0
4. Bradford S. Stone Other Registered Investment Companies: 3 1,430 0
Other Pooled Investment Vehicles: 1 194 0
Other Accounts: 12 2,155 0
POTENTIAL CONFLICTS OF INTEREST
In addition to the Fund, the Portfolio Managers jointly manage accounts for
three other closed-end funds, one Canadian fund and other institutional clients.
As a result, potential conflicts of interest may arise as follows:
- ALLOCATION OF LIMITED TIME AND ATTENTION. The Portfolio Managers may devote
unequal time and attention to the management of all accounts. As a result,
the Portfolio Managers may not be able to formulate as complete a strategy
or identify equally attractive investment opportunities for each of those
accounts as might be the case if they were to devote substantially more
attention to the management of one account.
- ALLOCATION OF LIMITED INVESTMENT OPPORTUNITIES. If the Portfolio Managers
identify an investment opportunity that may be suitable for multiple
accounts, the Fund may not be able to take full advantage of that
opportunity because the opportunity may need to be allocated among other
accounts.
- PURSUIT OF DIFFERING STRATEGIES. At times, the Portfolio Managers may
determine that an investment opportunity may be appropriate for only some
accounts or may decide that certain of these accounts should take differing
positions (i.e., may buy or sell the particular security at different times
or the same time or in differing amounts) with respect to a particular
security. In these cases, the Portfolio Manager may place separate
transactions for one or more accounts which may affect the market price of
the security or the execution of the transaction, or both, to the detriment
of one or more other accounts.
- VARIATION IN COMPENSATION. A conflict of interest may arise where the
financial or other benefits available to the Portfolio Manager differ among
accounts. While the Adviser only charges fees based on assets under
management and does not receive a performance fee from any of its accounts,
and while it strives to maintain uniform fee schedules, it does have
different fee schedules based on the differing advisory services required
by some accounts. Consequently, though the differences in such fee rates
are slight, the Portfolio Managers may be motivated to favor certain
accounts over others. In addition, the desire to maintain assets under
management or to derive other rewards, financial or otherwise, could
influence the Portfolio Managers in affording preferential treatment to
those accounts that could most significantly benefit the Adviser.
The Adviser and the Fund have adopted compliance policies and procedures that
are designed to address the various conflicts of interest that may arise for the
Adviser and its staff members. However, there is no guarantee that such policies
and procedures will be able to detect and prevent every situation in which an
actual or potential conflict may arise.
(A)(3) PORTFOLIO MANAGER COMPENSATION
Compensation is paid solely by the Adviser. Each Portfolio Manager receives the
same fixed salary. In addition, each Portfolio Manager receives a bonus based on
peer reviews of his performance and the total net investment advisory fees
received by Flaherty & Crumrine (which are in turn based on the value of its
assets under management). The Portfolio Managers do not receive deferred
compensation, but participate in a profit-sharing plan available to all
employees of the Adviser; amounts are determined as a percentage of the
employee's eligible compensation for a calendar year based on IRS limitations.
Each Portfolio Manager is also a shareholder of Flaherty & Crumrine and receives
quarterly dividends based on his equity interest in the company.
(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
The following indicates the dollar range of beneficial ownership of shares by
each Portfolio Manager as of November 30, 2010:
Dollar Range of Fund Shares
Name Beneficially Owned*
------------------ ---------------------------
Donald F. Crumrine $100,001 to $500,000
Robert M. Ettinger $100,001 to $500,000
R. Eric Chadwick $100,001 to $500,000
Bradford S. Stone $100,001 to $500,000
* INCLUDES 7,169 SHARES HELD BY FLAHERTY & CRUMRINE INCORPORATED OF WHICH
EACH PORTFOLIO MANAGER HAS BENEFICIAL OWNERSHIP.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these
controls and procedures required by Rule 30a-3(b) under the 1940 Act
(17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the
Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act
(17 CFR 270.30a-3(d)) that occurred during the registrant's second
fiscal quarter of the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of ethics, or any amendment thereto, that is the subject of
disclosure required by Item 2 is attached hereto.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) Flaherty & Crumrine Preferred Income Fund Incorporated
By (Signature and Title)* /s/ Donald F. Crumrine
-------------------------------------
Donald F. Crumrine, Director,
Chairman of the Board and Chief
Executive Officer
(principal executive officer)
Date January 26, 2011
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /s/ Donald F. Crumrine
-------------------------------------
Donald F. Crumrine, Director,
Chairman of the Board and Chief
Executive Officer
(principal executive officer)
Date January 26, 2011
By (Signature and Title)* /s/ R. Eric Chadwick
-------------------------------------
R. Eric Chadwick, Chief Financial
Officer, Treasurer and Vice President
(principal financial officer)
Date January 26, 2011
* Print the name and title of each signing officer under his or her
signature.