PREFERRED INCOME FUND INCORPORATED
Dear Shareholder:
The Preferred Income Fund turned in a banner quarter despite an extremely
difficult market for fixed income securities. The Fund earned 2.4% on net asset
value ("NAV") during its third fiscal quarter. For the first three fiscal
quarters of 2003, the return on NAV was a remarkable 22.1%.
The extraordinary jump in intermediate and long-term interest rates during
the quarter provided a textbook case for why we hedge against a substantial rise
in interest rates. The yields on 10-year and 30-year U.S. Treasuries rose 1.10%
and 0.86%, respectively, during the period. An investor in these securities
would have suffered total return LOSSES of 7.8% on the 10-year and 10.9% on the
30-year.
Given the magnitude of the weakness in the fixed-income markets, it is no
surprise that the performance of the market price for the Fund's shares lagged
the performance of the NAV. For the quarter, the return on market was -4.5%.
Since the beginning of the fiscal year, the market return was a much more
impressive +10.7%.
This was clearly one of the worst three months the bond market has ever
experienced, and without the Fund's hedging strategy the results would have been
much worse. In some ways, hedging is a lot like buying an insurance policy - you
pay a premium, but don't expect to collect very often. When you need it,
however, you are awfully glad you have it! During the past quarter we certainly
needed the hedge; WITHOUT IT, THE RETURN ON NAV WOULD HAVE BEEN 4.8 PERCENTAGE
POINTS LOWER.
Interest in preferred securities remains high, but on balance there has not
been a lot of new supply. As you would expect, these conditions have resulted in
the yields on preferreds narrowing versus the yields on Treasury notes and
bonds. Despite this, when compared to historical relationships, preferred
securities still appear attractively priced at present.
We are always on the lookout for the best values within the preferred
securities market. For some period of time now, we have determined that
traditional preferred stock (the type which pays dividends that may be taxed at
lower rates for corporations and individuals) should comprise a larger portion
of the Fund's investment portfolio. Of course, in the future, fully taxable
hybrid preferred securities may become more attractive and make up a bigger part
of the portfolio.
A lot of investors have inquired about the percentage of the Fund's
distributions which are dividends (as opposed to interest). Because of the way
the tax rules work, that number cannot be calculated until the end of the fiscal
year. We have added a section on the Fund's web site, www.preferredincome.com,
which shows the breakdown between dividends, income and capital gains from prior
years.
We strongly encourage shareholders to participate in the Fund's Dividend
Reinvestment and Cash Purchase Plan ("DRIP"). It provides a steady, reliable
approach to building wealth.
Sincerely,
/S/ Donald F. Crumrine /S/ Robert M. Ettinger
Donald F. Crumrine Robert M. Ettinger
Chairman of the Board President
September 30, 2003
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Preferred Income Fund Incorporated
SUMMARY OF INVESTMENTS
AUGUST 31, 2003 (UNAUDITED)
-----------------------------------
PERCENT
VALUE OF TOTAL
(000'S) NET ASSETS
------- ----------
ADJUSTABLE RATE PREFERRED SECURITIES
Utilities ...................................................................... $ 382 0.2%
Banking ........................................................................ 22,023 9.2
Financial Services ............................................................. 524 0.2
-------- -----
TOTAL ADJUSTABLE RATE ...................................................... 22,929 9.6
-------- -----
FIXED RATE PREFERRED SECURITIES
Utilities ...................................................................... 80,016 33.5
Banking ........................................................................ 50,062 21.0
Financial Services ............................................................. 24,214 10.2
Insurance ...................................................................... 22,422 9.4
Oil and Gas .................................................................... 8,453 3.5
Miscellaneous Industries ....................................................... 4,249 1.8
-------- -----
TOTAL FIXED RATE ........................................................... 189,416 79.4
-------- -----
INVERSE FLOATING RATE PREFERRED SECURITIES .......................................... 1,529 0.6
TOTAL PREFERRED STOCKS AND SECURITIES ............................................... 213,874 89.6
CORPORATE DEBT SECURITIES ........................................................... 2,114 0.9
COMMON STOCKS AND CONVERTIBLE SECURITIES ............................................ 6,088 2.6
PURCHASED PUT OPTIONS ............................................................... 3,189 1.3
MONEY MARKET FUNDS .................................................................. 9,751 4.1
-------- -----
TOTAL INVESTMENTS ................................................................... 235,016 98.5
OTHER ASSETS AND LIABILITIES (NET) .................................................. 3,550 1.5
-------- -----
TOTAL NET ASSETS AVAILABLE TO COMMON AND PREFERRED STOCK ....................... $238,566 100.0%
======== =====
FINANCIAL DATA
PER SHARE OF COMMON STOCK (UNAUDITED)
-------------------------------------
DIVIDEND
DIVIDEND NET ASSET NYSE REINVESTMENT
PAID VALUE CLOSING PRICE PRICE (1)
-------- --------- ------------- ------------
December 31, 2002 Extra ........................... $0.1285 $13.65 $15.10 $14.35
December 31, 2002 ................................. 0.0915 13.65 15.10 14.35
January 31, 2003 .................................. 0.0915 14.45 16.70 15.87
February 28, 2003 ................................. 0.0915 14.55 16.42 15.60
March 31, 2003 .................................... 0.0915 14.64 16.10 15.30
April 30, 2003 .................................... 0.0915 14.83 16.20 15.39
May 31, 2003 ...................................... 0.0915 15.54 16.63 15.80
June 30, 2003 ..................................... 0.0915 15.84 16.35 15.84
July 31, 2003 ..................................... 0.0915 15.58 15.34 15.27
August 31, 2003 ................................... 0.0915 15.64 15.61 15.64
--------------------
(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 payment 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.
4
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STATEMENT OF CHANGES IN NET ASSETS AVAILABLE TO COMMON STOCK(1)
NINE MONTHS ENDED AUGUST 31, 2003 (UNAUDITED)
----------------------------------------------------------------
VALUE
(000'S)
-------
OPERATIONS:
Net investment income ........................................................................ $ 9,871
Net realized gain on investments sold during the period ...................................... 6,715
Change in net unrealized appreciation of investments held during the period .................. 14,091
Distributions to Money Market Cumulative PreferredTM Stock Shareholders from net investment
income, including changes in accumulated undeclared distributions ........................ (831)
Decrease due to Money Market Cumulative PreferredTM Stock offering expenses .................. 0
-------------
Net increase in net assets from operations ............................................... 29,846
DISTRIBUTIONS:
Dividends paid from net investment income to Common Stock Shareholders (2) ................... (9,607)
Distributions paid from net realized capital gains to Common Stock Shareholders .............. 0
-------------
Total Distributions ...................................................................... (9,607)
-------------
FUND SHARES TRANSACTIONS:
Increase from Common Stock Transactions ...................................................... 1,508
Decrease due to Money Market Cumulative PreferredTM Stock Offering Costs ..................... (6)
-------------
NET INCREASE IN NET ASSETS AVAILABLE TO COMMON STOCK FOR THE PERIOD ............................... 21,741
NET ASSETS AVAILABLE TO COMMON STOCK:
Beginning of period .......................................................................... 136,756
-------------
End of period ................................................................................ $ 158,497
=============
FINANCIAL HIGHLIGHTS(1)
NINE MONTHS ENDED AUGUST 31, 2003 (UNAUDITED)
FOR A COMMON SHARE OUTSTANDING THROUGHOUT THE PERIOD.
-----------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period ......................................................... $ 13.63
-------------
INVESTMENT OPERATIONS:
Net investment income ........................................................................ 0.97
Net realized gain and unrealized appreciation on investments ................................. 2.07
DISTRIBUTIONS TO MMP* SHAREHOLDERS:
From net investment income (including change in accumulated undeclared dividends on MMP*) .... (0.08)
From net realized capital gains .............................................................. 0.00
-------------
Total from investment operations after distribution to MMP* Shareholders ..................... 2.96
-------------
DISTRIBUTIONS TO COMMON STOCK SHAREHOLDERS:
From net investment income ................................................................... (0.95)
From net realized capital gains .............................................................. 0.00
-------------
Total distributions to Common Stock Shareholders ............................................. (0.95)
-------------
Net asset value, end of period ............................................................... $ 15.64
=============
Market value, end of period .................................................................. $ 15.61
=============
Common shares outstanding, end of period ..................................................... 10,132,249
=============
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK SHAREHOLDERS:
Net investment income ........................................................................ 8.01%**
Operating expenses ........................................................................... 1.51%**
--------------------------------------------------------
SUPPLEMENTAL DATA:++
Portfolio turnover rate fiscal year to date .................................................. 25%***
Total net assets available to Common and Preferred Stock, end of period (in 000's) ........... $ 238,566
Ratio of operating expenses to total average net assets including MMP* ....................... 0.98%**
(1) These tables summarize the nine months ended August 31, 2003 and should be
read in conjunction with the Fund's audited financial statements, including
footnotes, contained in its Annual Report dated November 30, 2002.
(2) Includes income earned, but not paid out, in prior fiscal year.
* Money Market Cumulative PreferredTM Stock.
** Annualized.
*** Not Annualized.
++ Information presented under heading Supplemental Data includes MMP*.
5
DIRECTORS
Martin Brody
Donald F. Crumrine, CFA
Robert M. Ettinger, CFA
David Gale
Morgan Gust
Robert F. Wulf, CFA
OFFICERS
Donald F. Crumrine, CFA
Chairman of the Board
and Chief Executive Officer
Robert M. Ettinger, CFA
President
Peter C. Stimes, CFA
Chief Financial and Accounting
Officer, Vice President
and Treasurer
Robert E. Chadwick, CFA
Vice President and Secretary
Bradford S. Stone
Vice President
INVESTMENT ADVISER
Flaherty & Crumrine Incorporated
e-mail: flaherty@fin-mail.com
QUESTIONS CONCERNING YOUR SHARES OF PREFERRED
INCOME FUND?
o If your shares are held in a Brokerage
Account, contact your Broker.
o If you have physical possession of your shares
in certificate form, contact the Fund's Transfer
Agent & Shareholder Servicing Agent --
PFPC Inc.
P.O. Box 43027
Providence, RI02940-3027
1-800-331-1710
THIS REPORT IS SENT TO SHAREHOLDERS OF 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.
[GRAPHIC]
PREFERRED
INCOME
FUND
QUARTERLY
REPORT
AUGUST 31, 2003
web site: www.preferredincome.com