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, 2009
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:
The fiscal year ended on a positive note, posting solid returns for the
third consecutive quarter. As can be seen in the table below, the eye-popping
performance of recent periods tells only part of the story, but one we are happy
to report!
TOTAL RETURN ON NET ASSET VALUE
FOR PERIODS ENDED NOVEMBER 30, 2009
ACTUAL RETURNS AVERAGE ANNUALIZED RETURNS
----------------------- -------------------------------
THREE SIX ONE THREE FIVE TEN LIFE OF
MONTHS MONTHS YEAR YEARS YEARS YEARS FUND(2)
------ ------ ---- ----- ----- ----- -------
Flaherty & Crumrine Preferred
Income Fund (1)............................ 14.8% 42.8% 82.5% -6.4% -0.8% 4.5% 8.5%
Barclays Capital U.S. Aggregate Index (3).. 2.9% 6.2% 11.6% 6.4% 5.5% 6.4% 7.0%
S&P 500 Index (4).......................... 7.9% 20.5% 25.2% -5.8% 0.7% -0.6% 8.6%
---------
(1) In prior periods, the Fund included the performance of funds in Lipper's
Domestic Investment-Grade funds category, which reflected the
equally-weighted average performance returns of all closed-end funds in the
category in each month during the period. The category last included
closed-end funds in the U.S. Mortgage and Corporate Debt BBB Rated
sub-categories and has included other sub-categories in prior periods. With
Lipper no longer publishing these results in a comparable format, the Fund
will no longer include these results. For the period ended November 30,
2009, this category returned 5.8%, 15.4%, 31.0%, 3.9%, 4.5%, 6.2% and 7.0%
(for the three month, six month, one year, three year, five year, ten year
and since inception periods).
(2) Since inception on January 31, 1991.
(3) 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.
(4) The S&P 500 is a capitalization-weighted index of 500 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 financial crisis of the past two years claimed countless casualties and
caused greater market volatility in the preferred market than any time in
memory. A double digit return, up or down, was unusual before the crisis, yet
such numbers have recently become more common.(1)
For all of fiscal 2009, the NAV INCREASED 82.5% as the market for preferred
securities came back to life. Although recent performance is impressive, it has
not been enough to offset the decline of 48.4% in fiscal 2008. Unfortunately, it
takes a lot more positive percentage returns to overcome a given amount of
negative return. And if that's not enough to induce some head scratching, the
analysis is further complicated by changes in the amount of leverage used by the
Fund. We delve more deeply into these numbers, as well as returns on the market
price of Fund shares, in the discussion section.
----------
(1) The Fund's interest rate hedging strategy generally helps dampen volatility
of returns, but the decision to temporarily suspend such hedging late last
year has had little impact on performance (more on this later).
To help readers put the Fund's performance in context, we've included
returns for broader fixed-income and equity markets. Other performance
comparisons are discussed more thoroughly in the discussion section which
follows.
Conditions in the preferred securities market have improved dramatically.
Efforts by various government agencies, especially the Federal Reserve, have
clearly helped stabilize the financial sector; prices of securities issued by
commercial banks and insurance companies have recovered much of their lost
value. Another factor contributing to the rebound in the preferred market is the
absence of alternative investments such as asset-backed securities,
collateralized debt obligations and commercial mortgage-backed securities.
Investors have returned to more traditional investments like preferred
securities, as the supply of "alternative" products has virtually disappeared.
Although risks remain, the outlook for the preferred securities market
seems bright. Market liquidity has improved and new securities are being issued.
Confidence in the banking sector has improved, as banks have repaid more than
70% of the TARP preferreds issued during the height of the financial crisis.
There are also indications that increased standardization of preferred security
structures may be coming down the road, something investors would welcome.
The fact that the government used preferred stock investments to provide
capital to distressed companies is an indication of how important these
securities are in the world of finance. Without preferred securities, the number
of companies that failed during the financial crisis would likely have been far
greater.
In another sign of better times, the Fund announced an increase in the
monthly distribution to $0.072 from $0.063 beginning with the December 2009
dividend. Several factors contributed to the increase, including changes to the
Fund's leverage. The impact of leverage, investment income and Fund expenses on
the amount of the dividend can get confusing, but it is important for
shareholders to understand how the distributions are determined. We attempt to
clarify things a bit in the discussion section.
More information is always available on the Fund's website, including
expanded discussion of many of the topics in this letter. In addition, our
thoughts on the economic outlook are published quarterly and posted to the site.
We encourage you to visit the website at www.preferredincome.com.
Sincerely,
/s/ Donald F. Crumrine /s/ Robert M. Ettinger
------------------------------------- ----------------------------------------
Donald F. Crumrine Robert M. Ettinger
Chairman of the Board President
January 21, 2010
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 interest rate hedging); 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 the total return on NAV.
COMPONENTS OF PFD'S TOTAL RETURN ON NAV
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 2009
SIX MONTHS* ONE YEAR
----------- --------
Total Return on Unleveraged Securities Portfolio
(including principal and income) .................. +27.7% +51.7%
Return from Interest Rate Hedging Strategy ........ 0.0% 0.0%
Impact of Leverage (including leverage expense) ... +16.0% +32.8%
Expenses (excluding leverage expense) ............. -0.9% -2.0%
------- ------
* Actual, not annualized. TOTAL RETURN ON NAV +42.8% +82.5%
By the end of the Fund's fiscal year ended November 30th, the preferred
market had recovered dramatically from the lows it reached in 2008 and early
2009. More importantly, as can be seen by comparing the total return on the
securities portfolio (the first row of the above table) to the index results in
the following table, the Fund's portfolio outperformed the three largest
segments of the market. The fourth segment of the market, adjustable rate
preferred securities, constitutes roughly 3% of the entire preferred market as
well as of the Fund's portfolio.
TOTAL RETURNS OF BANK OF AMERICA MERRILL LYNCH PREFERRED SECURITIES INDICES*
FOR PERIODS ENDED NOVEMBER 30, 2009
SIX MONTHS ONE YEAR
---------- --------
BofA Merrill Lynch 8% Capped DRD Preferred Stock Index(SM) ................ +20.5% +25.1%
BofA Merrill Lynch 8% Capped Hybrid Preferred Securities Index(SM) ........ +13.9% +27.8%
BofA Merrill Lynch 8% Capped Corporate U.S. Capital Securities Index(SM) .. +26.8% +49.2%
BofA Merrill Lynch Adjustable Preferred Stock, 7% Constrained Index(SM) ... +43.0% +87.9%
* 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 dividend 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
The bottom line of the Fund's performance (as well as the bottom line of
the first table) demonstrates how leverage benefited common stock shareholders
during the past year. In contrast to the experience during fiscal 2008, the
strategy of using leverage to increase current income magnified the positive
returns over the Fund's fiscal 2009, and, even net of its expenses, caused the
NAV of the Fund (with the added benefit of leverage) to significantly outperform
the three largest unleveraged preferred market 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. After hitting lows in late 2008, the Funds'
market price improved dramatically in 2009, and for the twelve months ending
November 30, 2009, the total return on market price of Fund shares was +78.8%.
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 below, this often is not
the case. For most of the past year the market price has been below the NAV (in
market parlance, "trading at a discount"). Recently, the discount narrowed and
the market price is more in line with the underlying value of each Fund share.
FLAHERTY & CRUMRINE PREFERRED INCOME FUND (PFD)
PREMIUM/DISCOUNT OF MARKET PRICE TO NAV THROUGH 12/31/2009
(PERFORMANCE GRAPH)
TOTAL RETURN CHART - PAGE 4
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
7/30/99 -0.0751
8/6/99 -0.0792
8/13/99 -0.0963
8/20/99 -0.0946
8/27/99 -0.0911
9/3/99 -0.1071
9/10/99 -0.0892
9/17/99 -0.1065
9/24/99 -0.0788
10/1/99 -0.0703
10/8/99 -0.0727
10/15/99 -0.1442
10/22/99 -0.1279
10/29/99 -0.1431
11/5/99 -0.1368
11/12/99 -0.1373
11/19/99 -0.1078
11/26/99 -0.1207
12/3/99 -0.1115
12/10/99 -0.1164
12/17/99 -0.1277
12/24/99 -0.1624
12/31/99 -0.1084
1/7/00 -0.0771
1/14/00 -0.0451
1/21/00 -0.1203
1/28/00 -0.1392
2/4/00 -0.0511
2/11/00 -0.0641
2/18/00 -0.0872
2/25/00 -0.0812
3/3/00 -0.0585
3/10/00 -0.0526
3/17/00 -0.0706
3/24/00 -0.1058
3/31/00 -0.1052
4/7/00 -0.0782
4/14/00 -0.0904
4/21/00 -0.0868
4/28/00 -0.0757
5/5/00 -0.0591
5/12/00 -0.0608
5/19/00 -0.0438
5/26/00 -0.0407
6/2/00 -0.0482
6/9/00 -0.0639
6/16/00 -0.067
6/23/00 -0.0678
6/30/00 -0.08
7/7/00 -0.0807
7/14/00 -0.0755
7/21/00 -0.0842
7/28/00 -0.0816
8/4/00 -0.0851
8/11/00 -0.0865
8/18/00 -0.0672
8/25/00 -0.0851
9/1/00 -0.0681
9/8/00 -0.0794
9/15/00 -0.0858
9/22/00 -0.0905
9/29/00 -0.1071
10/6/00 -0.0866
10/13/00 -0.0872
10/20/00 -0.0845
10/27/00 -0.0695
11/3/00 -0.0571
11/10/00 -0.0734
11/17/00 -0.0991
11/24/00 -0.1379
12/1/00 -0.0864
12/8/00 -0.0877
12/15/00 -0.1171
12/22/00 -0.0939
12/29/00 -0.0965
1/5/01 -0.0328
1/12/01 0.0028
1/19/01 -0.0285
1/26/01 -0.036
2/2/01 -0.0414
2/9/01 -0.029
2/16/01 -0.0314
2/23/01 -0.0321
3/2/01 0.0007
3/9/01 -0.0517
3/16/01 -0.0586
3/23/01 -0.0288
3/30/01 -0.0203
4/6/01 -0.0094
4/13/01 0.0117
4/20/01 -0.0229
4/27/01 -0.0088
5/4/01 0.0072
5/11/01 -0.0146
5/18/01 0.0029
5/25/01 -0.016
6/1/01 0.018
6/8/01 -0.0215
6/15/01 -0.0405
6/22/01 -0.0503
6/29/01 -0.0258
7/6/01 0.0064
7/13/01 -0.041
7/20/01 0.0021
7/27/01 0.0308
8/3/01 -0.0175
8/10/01 -0.0473
8/17/01 -0.0282
8/24/01 -0.0221
8/31/01 -0.0475
9/7/01 -0.0007
9/14/01 -0.0007
9/21/01 -0.0173
9/28/01 -0.012
10/5/01 0.0069
10/12/01 0.023
10/19/01 -0.009
10/26/01 0.0275
11/2/01 0.0089
11/9/01 0.0034
11/16/01 0.0178
11/23/01 0.022
11/30/01 -0.0096
12/7/01 0.0138
12/14/01 0.0152
12/21/01 0.043
12/28/01 0.0271
1/4/02 0.0437
1/11/02 0.0323
1/18/02 0.0447
1/25/02 0.0608
2/1/02 0.0754
2/8/02 0.0924
2/15/02 0.0755
2/22/02 0.1158
3/1/02 0.1186
3/8/02 0.0395
3/15/02 0.0437
3/22/02 0.0212
3/29/02 0.0212
4/5/02 0.0246
4/12/02 0.0423
4/19/02 0.0539
4/26/02 0.0312
5/3/02 0.0468
5/10/02 0.0408
5/17/02 0.0434
5/24/02 0.0542
5/31/02 0.0543
6/7/02 0.0704
6/14/02 0.0505
6/21/02 0.0478
6/28/02 0.087
7/5/02 0.0691
7/12/02 0.0545
7/19/02 0.1276
7/26/02 0.1241
8/2/02 0.1051
8/9/02 0.0865
8/16/02 0.1032
8/23/02 0.1103
8/30/02 0.1209
9/6/02 0.1169
9/13/02 0.0972
9/20/02 0.0948
9/27/02 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
12/5/03 0.1202
12/12/03 0.1321
12/19/03 0.1348
12/26/03 0.1471
1/2/04 0.155
1/9/04 0.1432
1/16/04 0.1418
1/23/04 0.1599
1/30/04 0.1306
2/6/04 0.134
2/13/04 0.1366
2/20/04 0.1633
2/27/04 0.1588
3/5/04 0.1749
3/12/04 0.169
3/19/04 0.1859
3/26/04 0.2086
4/2/04 0.181
4/9/04 0.0637
4/16/04 0.0453
4/23/04 0.0119
4/30/04 0.0107
5/7/04 -0.0108
5/14/04 0.0206
5/21/04 0.0682
5/28/04 0.1405
6/4/04 0.118
6/11/04 0.1393
6/18/04 0.1446
6/25/04 0.1479
7/2/04 0.139
7/9/04 0.1269
7/16/04 0.1148
7/23/04 0.1175
7/30/04 0.0982
8/6/04 0.1063
8/13/04 0.1201
8/20/04 0.1635
8/27/04 0.1613
9/3/04 0.1708
9/10/04 0.1722
9/17/04 0.1653
9/24/04 0.1349
10/1/04 0.1391
10/8/04 0.1691
10/15/04 0.1668
10/22/04 0.1718
10/29/04 0.1626
11/5/04 0.1553
11/12/04 0.1617
11/19/04 0.1706
11/26/04 0.1659
12/3/04 0.098
12/10/04 0.0919
12/17/04 0.1169
12/24/04 0.1499
12/31/04 0.1485
1/7/05 0.1541
1/14/05 0.1296
1/21/05 0.1385
1/28/05 0.1461
2/4/05 0.1303
2/11/05 0.1475
2/18/05 0.1687
2/25/05 0.1578
3/4/05 0.13
3/11/05 0.1076
3/18/05 0.0069
3/25/05 -0.0114
4/1/05 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
Based on a closing price of $10.47 on December 31st, the current
distribution rate on the market price of the Fund's shares (assuming the current
monthly distribution of $0.072 does not change) is 8.3%. In our opinion, this
distribution rate measures up favorably with most comparable investment
opportunities.
PREFERRED MARKET CONDITIONS
Conditions in the preferred securities market have improved markedly since
the very dark days of last winter. By late February 2009, prices on preferred
securities had fallen to such a degree that the market seemed to be predicting
few companies would survive. And while the severe economic downturn did claim
its victims, the vast majority of companies appear to be well on the way to full
recovery.
4
By most measures, key aspects of the preferred market are returning to
normal levels. Trading has improved; there has been a steady supply of new
issues; market participation appears widespread; and valuation metrics appear
more consistent with other market segments. Of course, the most important
measure of whether the preferred market has returned to normal levels is price.
In our opinion, prices on much of the universe of preferred securities remain
attractive, especially when compared to pre-crisis levels.
Since March, there have been almost thirty new preferred issues, totaling
over $16 billion. Although some of the new issues have been in exchange for
older preferred securities, there has been new supply, and investors appear to
have an appetite for more.
Perceptions of credit quality have also improved recently. Bolstered by
banks returning bailout funds to the government (discussed below), investor
confidence is coming back. The market reacted positively to each announcement of
the Troubled Asset Relief Program (TARP) repayment, especially those of Bank of
America and Citigroup. In addition to paying back the government, a number of
banks raised new capital (common and preferred) in a sign that traditional
financing sources are opening up again.
Though banks have the most preferred securities outstanding, preferred
securities of insurance companies and public utilities constitute the other
large sectors of the preferred securities universe. The insurance industry has
generally benefited from improved investment performance and very few natural
catastrophes. A number of insurance companies repurchased a portion of their
outstanding preferred securities in recent months; in turn, the market prices of
their remaining securities have risen substantially. Utilities, largely
unaffected by the financial crisis, have continued to perform well, as investors
seek perceived safety and diversification.
From time to time, the national credit rating agencies, primarily Moody's,
Standard & Poor's, and Fitch, have revised the methodology they use to rate
preferred securities. We rely primarily on our own research to evaluate credit
quality, but the impact of public ratings can't be ignored. So when the agencies
recently announced changes (once again!) to the methodology they employ in
rating preferred securities, we were a bit dismayed. However, the market took it
in stride, and despite a number of downgrades, prices changed little, if at all.
In December, a little known, but extremely important international
committee based in Basel, Switzerland, proposed stricter guidelines for the way
banks account for capital raised by issuing preferred securities. From our
initial read of the guidelines, it appears that, after a transition period, in
order for banks to receive the most favorable regulatory treatment from
preferred capital, the issues will have to look more like old fashioned
perpetual preferred stock. In addition, the U.S. Congress is considering new
regulations for financial institutions that will affect many of the issuers in
the Fund's portfolio. Of course, we'll monitor these developments closely and
keep you informed, but we are optimistic that these changes will be beneficial
to the Fund.
The preferred securities market, much like the broader stock and bond
markets, took some severe hits during the financial crisis, and we still expect
some bumps in the road to complete recovery in our markets. That being said, we
aren't surprised by the extent of the ongoing recovery, even if the speed at
which it has occurred has been faster than we imagined.
BANK REPAYMENT OF TARP PREFERRED AND IMPACT ON PREFERRED INVESTORS
In aggregate, U.S. banks have repaid about $188 billion of the roughly $264
billion in preferred capital purchased from them by the TARP. Focusing on the 19
largest banks that were subject to the Supervisory
5
Capital Assessment Program (SCAP), 18 of these banks received approximately $221
billion in TARP capital and 12 of them have repaid about $182 billion as of
December 18, 2009.(2) This has turned out to be a significantly faster timetable
for repayment than most market participants expected, and it highlights that (1)
policies implemented to protect the financial system were largely effective and
(2) the health of the banking system is improving rapidly.
All of the money-center banks and most of the major trust banks have repaid
their TARP capital. These institutions have viewed repayment as important to
their business. They believe that customers have a higher degree of confidence
doing business - particularly when it involves counterparty risk - with a bank
that has repaid the Treasury.
On the other hand, most regional and community banks have not yet repaid
their TARP capital. This is not a bad thing for preferred investors. Although
our assessment of their ability to repay TARP capital varies among regional and
community banks, we believe that it is prudent for them to hold on to the
capital at this time. While economic and financial conditions have improved,
aggregate loan losses are still increasing. We expect them to peak in 2010, but
some geographic regions and loan categories (e.g., commercial real estate) are
likely to turn around more slowly. Regional and community banks, particularly
smaller ones, tend to have more geographic, and often more loan-category,
concentration than larger money-center banks, which makes them more exposed to
those uncertainties. As a result, we do not fault these banks for holding on to
their TARP capital for a while longer. If the economic recovery proceeds as
expected and loan losses begin to trend down, we expect that most of the
remaining banks will repay their TARP capital in 2010. However, banks with tough
geographic footprints or concentrations of problem loans may not repay their
TARP capital for several more years, and some will not survive at all.
As preferred investors, we care more about the quality of a bank's loan
book, its business prospects, and the quantity and composition of its capital
than whether or not it has repaid the TARP. We generally are happy to see banks
repay the Treasury as long as they issue a meaningful amount of common equity to
fund the repayment - something nearly all of the banks that have repaid the TARP
have done.
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.
This meant that hedging interest rates using put options on Treasury futures as
had been done historically added risk to the Fund, which emphatically is not the
objective of the hedging program. Second, the cost of hedging rose dramatically
as the yield curve steepened and options
----------
(2) Citigroup received a total of $45 billion in TARP capital and issued $7.1
billion in additional preferreds to the U.S. Treasury as payment for
insurance on $301 billion of troubled assets. Treasury later exchanged $25
billion of TARP preferred for common equity. (We include this amount as
"repaid," since it is no longer a Citigroup obligation.) As part of the
repayment plan announced on December 14, 2009, Citigroup will repay the
balance of $20 billion in TARP preferred, but $5.3 billion of the
"additional preferreds" will remain outstanding. The other banks that have
repaid their TARP capital are: American Express, Bank of America, BB&T
Bank, Bank of New York Mellon, Capital One Financial, Goldman Sachs, JP
Morgan Chase, Morgan Stanley, State Street Bank & Trust, U.S. Bancorp, and
Wells Fargo.
6
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 the market conditions at the time. (For a more detailed explanation,
see "Update on Hedging Strategy," July 6, 2009 on the Fund's web site.)
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,
most are not. For the preferred market as a whole, correlations between
movements in prices of preferreds and the hedge instruments we use are
increasing, but they remain well below their historical levels. While hedging
today probably would not add to risk as it did during the height of the crisis,
it still would not do much to reduce it. Meanwhile, the cost of hedging remains
high, and preferreds remain attractively priced.
However, it does appear that the preferred market is gradually moving back
toward a stronger relationship with swaps and Treasuries, even if that progress
is insufficient to persuade us to reestablish the hedging program at this time.
As the financial system heals, preferred securities are likely to reconnect with
long-term benchmark Treasury rates. When they do, we will consider hedging
again.
THE FUND'S LEVERAGE
As we have discussed in the past, there have been important changes in the
Fund's leverage since the beginning of the credit crisis. Most notably, during
the past year, the Fund redeemed all of its remaining outstanding auction
preferred stock, and instead began using debt for leverage. Equally important,
the amount of leverage in the Fund in dollars and as a percent of total assets
has changed.
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.
The Fund began a process of transitioning from auction preferred leverage
to bank debt leverage in early 2008. When it worked as intended, auction
preferred stock was a very efficient form of leverage. However the breakdown of
the auction process in late 2007 prompted us to seek alternative leverage. We
determined that a borrowing facility was the best available option.
In addition to economic considerations there is a set of rules that govern
leverage (most importantly, the terms and conditions of the leverage agreement,
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.
7
PFD LEVERAGE HISTORY
(PERFORMANCE GRAPH)
LEVERAGE MONTH END TOTAL MONEY MARKET LOAN AMOUNT
PERCENT DATE LEVERAGE PREFERRED STOCK DRAWN
-------- --------- -------- --------------- -----------
32.6%
32.9%
33.0%
32.7% 12/31/06 80 80 0
33.0% 1/31/07 80 80 0
33.2% 2/28/07 80 80 0
33.5% 3/31/07 80 80 0
33.7% 4/30/07 80 80 0
34.4% 5/31/07 80 80 0
34.9% 6/30/07 80 80 0
34.8% 7/31/07 80 80 0
34.8% 8/31/07 80 80 0
37.1% 9/30/07 80 80 0
38.3% 10/31/07 80 80 0
37.4% 11/30/07 80 80 0
37.5% 12/31/07 80 80 0
40.8% 1/31/08 80 80 0
40.6% 2/29/08 80 80 0
40.5% 3/31/08 80 80 0
42.3% 4/30/08 80 80 0
44.8% 5/31/08 80 80 0
44.8% 6/30/08 80 80 0
52.6% 7/31/08 80 80 0
50.0% 8/31/08 80 80 0
46.4% 9/30/08 80 80 0
45.6% 10/31/08 70 70 0
46.0% 11/30/08 55 55 0
45.2% 12/31/08 55 55 0
44.8% 1/31/09 55 55 0
42.5% 2/28/09 45 45 0
37.0% 3/31/09 45 45 0
35.4% 4/30/09 45 45 0
35.5% 5/31/09 45 45 0
35.4% 6/30/09 45 45 0
35.1% 7/31/09 45 0 45
35.3% 8/31/09 45 0 45
35.2% 9/30/09 50 0 50
33.9% 10/31/09 52 0 52
33.2% 11/30/09 52 0 52
32.8% 12/31/09 52 0 52
33.2%
32.6%
32.5%
33.3%
32.9%
33.4%
33.3%
33.3%
33.2%
33.1%
32.8%
33.3%
33.3%
33.5%
33.2%
33.2%
33.1%
33.1%
33.0%
32.8%
32.4%
32.4%
32.0%
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 of the portfolio moved up or
down. As can be seen in the chart, the leverage percentage climbed steadily as
the financial crisis unfolded 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, it has been easier and less expensive 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.
The "right" amount of leverage is never a simple matter to determine. Type
of borrowing, the cost of funds and market conditions will all be factors to
consider. At present, we are comfortable with the amount of the leverage. We
continuously monitor these factors and try to use leverage in a manner most
consistent with the Fund's objectives.
MONTHLY DISTRIBUTIONS TO FUND SHAREHOLDERS
The monthly distribution paid to shareholders is intended to reflect
current market conditions, but we also must make assumptions about the future.
We begin with an estimate of the sustainable income generated from the
investment portfolio, and end with a forecast of expenses, including the cost of
leverage. While it sounds simple, in periods of rapid change, forecasting income
and expenses becomes more art than science. There are always a lot of moving
parts when the Fund sets the monthly distribution, and the present is no
different.
With regard to income earned by the Fund, the financial crisis has claimed
many victims and there are a few Fund portfolio holdings that are not currently
making dividend or interest payments (noted as "non-
8
income producing" in the portfolio listing that follows). This obviously has a
direct impact on our forecasted income.
Historically, the Fund's use of auction preferred stock as leverage
encouraged it to invest in tax-advantaged (DRD-eligible) securities. As the Fund
has transitioned away from auction preferred stock, its portfolio has also
shifted to much greater percentages of fully-taxable securities. On a pre-tax
basis, this has had a positive impact on the amount of income earned by the
Fund, since fully-taxable securities typically yield more than tax-advantaged
ones. Of course, as detailed in the Supplementary Tax Information below, the
amount of income eligible for the corporate dividends received deduction (DRD)
has accordingly decreased.
The primary variables on the expense forecast are the cost and amount of
leverage employed by the Fund. During the year, we saw two different trends.
Late in 2008, the reduction in the AMOUNT of leverage (and the amount of
additional incremental income it provided) dwarfed the benefit the Fund would
have seen from its declining COST of leverage. As a result, the Fund began its
fiscal year with a dividend cut. In the second half of 2009, the Fund saw both
variables trend positive: the cost of leverage continued to drop and the amount
of leverage was increased. As we discussed in the shareholder letter, the
additional income provided by that additional leverage consequently allowed the
Fund to increase its dividend.
IMPACT OF THE FEDERAL RESERVE RAISING SHORT-TERM RATES
With the federal funds rate hovering near zero percent, it's fair to ask
what will happen to the Fund when the Fed inevitably raises short-term rates. We
have to start with the caveat that there is no comprehensive answer, since the
Fund's performance depends on a lot more than the fed funds rate, which is the
only interest rate that the Fed controls directly. Having said that, we believe
there are several likely repercussions of Fed tightening.
Higher short-term rates are likely to reduce income available to the Fund's
common stock shareholders. The Fund's cost of leverage would go up, whereas most
of the Fund's assets pay fixed dividends or interest. The Fund could hedge this
risk by fixing the cost of leverage for some period of time, but doing so would
certainly increase the cost of leverage today in exchange for possibly lowering
it in the future. Because the yield curve currently is steep, the market expects
short rates will rise significantly and soon. As of December 31, 2009, the
market was pricing-in 25-50 basis points (bp) of tightening by the Fed by June
2010, 100-125 bp of tightening by the end of 2010, and more than 250 bp of
tightening by the end of 2011. Hedging the cost of leverage locks in those
expected rate increases. Short-term interest rates may rise by more than that,
but we currently think the economic outlook favors low rates for a longer period
than the market expects. Nonetheless, when short-term rates eventually do rise,
it probably will strain the Fund's dividend.
While the impact of higher short-term rates on income is fairly clear,
their impact on preferred securities' prices is ambiguous. Higher short-term
rates normally are associated with higher long-term rates and lower preferred
prices. However, we don't think these are normal times! The Fed is not likely to
raise short-term rates until the economy is stronger, which in turn should be
positive for the credit outlook. With preferred valuations still being driven
more by credit developments than by the general level of interest rates, Fed
tightening - at least in moderate amounts - might actually be good news for
preferred prices. In addition, if the Fed tightens by less than the market
expects, long-term rates could fall, just as they did when the Fed tightened in
2004-05. In short, it's not obvious that long-term interest rates are set to
rise, even though higher short-term rates are inevitable at some point - and
it's even less clear that tighter monetary policy would be bad news for
preferreds. (This is another reason why the Fund's hedging program is on hold.)
9
Implicit in this analysis is the view that the Fed will not have to raise
short-term rates dramatically, which probably would push all rates higher. The
only reason we could anticipate such high short-term rates is a breakout of
inflation. Given soaring budget deficits and accommodative monetary policy,
sharply higher inflation down the road cannot be ruled out. However, as we have
discussed in recent Economic Updates, we do not think inflation will gain a
foothold over the near to medium term. If we are right about that, we think the
main impact of moderately tighter monetary policy on the Fund is likely to be
somewhat reduced income.
FEDERAL TAX ADVANTAGES OF 2009 CALENDAR YEAR DISTRIBUTIONS
In 2009, 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. In
calendar year 2009, approximately 54.0% of distributions made by the Fund was
eligible for QDI treatment. For an individual in the 28% tax bracket, this means
that the Fund's total distributions will only be taxed at a blended 21.0% 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, an individual in the 28% tax bracket who held 100 shares of Common
Stock of the Fund for the calendar year would have had to receive approximately
$84 in distributions from a traditional corporate bond fund to net the same
after-tax amount as the $77 in 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 37.4% 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 2010's distributions may not be the same (or even similar) to
2009.
AS PREVIOUSLY DISCUSSED, THE FUND REDEEMED ALL OF ITS OUTSTANDING AUCTION
PREFERRED STOCK DURING THE PAST YEAR AND BEGAN USING DEBT FOR LEVERAGE. THE
FOLLOWING DESCRIBES RISKS ASSOCIATED WITH LEVERAGING THE FUND THROUGH THE USE OF
BORROWING, WHICH DO NOT MATERIALLY DIFFER FROM THE RISKS THE FUND FORMERLY FACED
THROUGH LEVERAGING USING AUCTION PREFERRED STOCK.
Because the investment risk associated with investment assets purchased
with funds obtained through leveraging is borne solely by each Fund's Common
Stock shareholders, adverse movements in the price of the Fund's portfolio
holdings would have a more severe effect on the Fund's net asset value than if
the Fund were not leveraged. Leverage creates risks for the Fund's Common Stock
shareholders, including the likelihood of greater volatility of the Fund's net
asset value and the market price of its shares, and the risk that fluctuations
in interest rates on borrowings may affect the return to Common Stock
shareholders. If income from the securities purchased with such funds is not
sufficient to cover the cost of leverage, net income of the Fund would be less
than if leverage had not been used, and therefore the amount available for
distribution to Common Stock shareholders as dividends will be reduced. In such
an event, the Fund may nevertheless determine to maintain its leveraged position
in order to avoid capital losses on securities purchased with the leverage.
Further, all expenses associated with borrowing, such as interest expenses and
transaction costs, will be borne solely by the Fund's Common Stock shareholders.
If the asset coverage for borrowing declines below the limits specified in
the Investment Company Act of 1940 (the "1940 Act") or in the terms of the
financing arrangement, the Fund might be required to sell a
10
portion of its investments when it is not advantageous to do so. In the extreme,
sales of investments required to meet asset coverage tests imposed by the 1940
Act could also cause a Fund to lose its status as a regulated investment company
under the Internal Revenue Code of 1986, as amended (the "Code"). If a Fund were
unable to make adequate distributions to shareholders because of asset coverage
or other restrictions, it could fail to qualify as a regulated investment
company for federal income tax purposes, and, even if it did not fail to so
qualify, it could become liable for income and excise tax on the portion of its
earnings which are not distributed on a timely basis in accordance with
applicable provisions of the Code.
11
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OVERVIEW
NOVEMBER 30, 2009 (UNAUDITED)
FUND STATISTICS ON 11/30/09
---------------------------
Net Asset Value $ 9.82
Market Price $ 9.12
Discount 7.13%
Yield on Market Price 8.29%
Common Stock Shares Outstanding 10,671,285
MOODY'S RATINGS % OF NET ASSETS+
--------------- ----------------
AA 0.3%
A 20.9%
BBB 56.9%
BB 18.5%
Below "BB" 0.6%
Not Rated 1.2%
----
Below Investment Grade* 14.9%
* BELOW INVESTMENT GRADE BY BOTH MOODY'S AND S&P.
(PIE CHART)
INDUSTRY CATEGORIES % OF NET ASSETS+
------------------- ----------------
Other 2%
Banking 41%
Utilities 27%
Insurance 23%
Energy 6%
Financial Services 1%
TOP 10 HOLDINGS BY ISSUER % OF NET ASSETS+
------------------------- ----------------
Banco Santander 7.3%
PNC Financial Services 6.4%
Goldman Sachs 4.6%
Liberty Mutual Group 4.4%
Metlife 4.0%
Dominion Resources 3.8%
Comerica 3.4%
Capital One Financial 3.4%
Interstate Power & Light 3.0%
Enbridge Energy Partners 2.9%
% OF NET ASSETS**+
------------------
Holdings Generating Qualified Dividend Income (QDI) for Individuals 46%
Holdings Generating Income Eligible for the Corporate Dividends Received Deduction (DRD) 31%
** 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 2009
DISTRIBUTIONS.
+ NET ASSETS INCLUDE ASSETS ATTRIBUTABLE TO THE USE OF LEVERAGE.
12
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS
NOVEMBER 30, 2009
SHARES/$ PAR VALUE
------------ ------------
PREFERRED SECURITIES -- 95.7%
BANKING -- 40.8%
$ 2,750,000 Astoria Capital Trust I, 9.75% 11/01/29, Series B ............................................ $ 2,574,918(1)
417,300 Banco Santander, 10.50% Pfd., Series 10 ...................................................... 11,501,831**(1)(2)
48,700 Bank of America Corporation, 6.70% Pfd. ...................................................... 885,366*(1)
Barclays Bank PLC:
$ 2,400,000 6.278% .................................................................................... 1,794,000**(1)(2)
40,000 6.625% Pfd., Series 2 ..................................................................... 768,400**(2)
20,000 8.125% Pfd., Series 5 ..................................................................... 469,400**(2)
75,000 BB&T Capital Trust VI, 9.60% Pfd. ............................................................ 2,036,250(1)
$ 5,500,000 Capital One Capital III, 7.686% 08/15/36 ..................................................... 4,730,000(1)
$ 600,000 Capital One Capital VI, 8.875% 05/15/40 ...................................................... 597,757
CIT Group, Inc.:
32,500 5.189% Pfd., Series B ..................................................................... 54,844*++
$ 905,000 6.10% 03/15/67 ............................................................................ 85,975++
64,455 6.35% Pfd., Series A ...................................................................... 22,720*++
$ 5,210,000 Colonial BancGroup, 7.114%, 144A**** ......................................................... 15,630++
$ 7,100,000 Comerica Capital Trust II, 6.576% 02/20/37 ................................................... 5,360,500(1)
9,000 FBOP Corporation, Adj. Rate Pfd., 144A**** ................................................... 49,500*++
1,250 First Republic Preferred Capital Corporation, 10.50% Pfd., 144A**** .......................... 1,131,250(1)
22,500 First Republic Preferred Capital Corporation II, 8.75% Pfd., Series B, 144A**** .............. 485,156(1)
3,250 First Tennessee Bank, Adj. Rate Pfd., 144A**** ............................................... 1,715,391*(1)
$ 600,000 First Tennessee Capital I, 8.07% 01/06/27, Series A .......................................... 505,102
$ 500,000 First Tennessee Capital II, 6.30% 04/15/34, Series B ......................................... 282,725
$ 1,500,000 First Union Capital II, 7.95% 11/15/29 ....................................................... 1,496,181(1)
Goldman Sachs:
132,000 Adj. Rate Pfd., Series D .................................................................. 2,705,010*
$ 4,501,000 Capital II, 5.793% ........................................................................ 3,330,740(1)
2,500 STRIPES Custodial Receipts, Pvt. .......................................................... 1,165,000*
$ 500,000 HSBC USA Capital Trust II, 8.38% 05/15/27, 144A**** .......................................... 495,897
HSBC USA, Inc.:
43,900 Adj. Rate Pfd., Series D .................................................................. 924,644*(1)
113,700 6.50% Pfd., Series H ...................................................................... 2,500,547*(1)
2,500 $2.8575 Pfd. .............................................................................. 102,500*(1)
$ 950,000 JPMorgan Chase Capital XXVII, 7.00% 11/01/39, Series AA ...................................... 962,515
15,000 Keycorp Capital VIII, 7.00% Pfd. 06/15/66 .................................................... 289,838(1)
23,500 Keycorp Capital X, 8.00% Pfd. ................................................................ 505,250(1)
$ 550,000 Lloyds Banking Group PLC, 6.657%, 144A**** ................................................... 292,086**(2)+
31,500 PFGI Capital Corporation, 7.75% Pfd. ......................................................... 700,875(1)
The accompanying notes are an integral part of the financial statements.
13
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2009
SHARES/$ PAR VALUE
------------ ------------
PREFERRED SECURITIES -- (CONTINUED)
BANKING -- (CONTINUED)
274,200 PNC Financial Services, 9.875% Pfd., Series F ................................................ $ 7,776,998*(1)
$ 1,600,000 PNC Preferred Funding Trust III, 8.70%, 144A**** ............................................. 1,574,342(1)
20,100 Sovereign Capital Trust V, 7.75% Pfd. 05/22/36 ............................................... 496,922(1)
1,750 Sovereign REIT, 12.00% Pfd., Series A, 144A**** .............................................. 1,938,125
$ 1,000,000 Washington Mutual, 9.75%, 144A**** ........................................................... 10,000++
$ 1,600,000 Webster Capital Trust IV, 7.65% 06/15/37 ..................................................... 1,000,000(1)
$ 450,000 Wells Fargo Capital XV, 9.75% 09/26/13 ....................................................... 479,250
------------
63,813,435
------------
FINANCIAL SERVICES -- 0.4%
$ 500,000 General Electric Capital Corporation, 6.375% 11/15/67 ........................................ 411,855(1)
11,300 HSBC Finance Corporation, 6.36% Pfd. ......................................................... 217,440*
Lehman Brothers Holdings, Inc.:
15,000 5.67% Pfd., Series D ...................................................................... 6,750*++
19,500 5.94% Pfd., Series C ...................................................................... 7,800*++
25,000 6.50% Pfd., Series F ...................................................................... 4,063*++
27,500 7.95% Pfd. ................................................................................ 2,778*++
------------
650,686
------------
INSURANCE -- 20.2%
$ 1,000,000 Ace Capital Trust II, 9.70% 04/01/30 ......................................................... 1,147,542(1)(2)
Arch Capital Group Ltd.:
4,700 7.875% Pfd., Series B ..................................................................... 112,389**(2)
22,800 8.00% Pfd., Series A ...................................................................... 554,325**(1)(2)
AXA SA:
$ 1,500,000 6.379%, 144A**** .......................................................................... 1,226,250**(1)(2)
$ 4,000,000 6.463%, 144A**** .......................................................................... 3,105,000**(1)(2)
35,900 Axis Capital Holdings, 7.50% Pfd., Series B .................................................. 2,764,300(1)(2)
90,600 Delphi Financial Group, 7.376% Pfd. 05/15/37 ................................................. 1,582,103(1)
$ 3,540,000 Everest Re Holdings, 6.60% 05/15/37 .......................................................... 2,708,100(1)
Liberty Mutual Group:
$ 300,000 7.80% 03/15/37, 144A**** .................................................................. 240,000(1)
$ 4,500,000 10.75% 06/15/58, 144A**** ................................................................. 4,747,500(1)
$ 500,000 MetLife Capital Trust IV, 7.875% 12/15/37, 144A**** .......................................... 480,000(1)
$ 2,000,000 MetLife Capital Trust X, 9.25% 04/08/38, 144A**** ............................................ 2,100,000(1)
The accompanying notes are an integral part of the financial statements.
14
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2009
SHARES/$ PAR VALUE
------------ ------------
PREFERRED SECURITIES -- (CONTINUED)
INSURANCE -- (CONTINUED)
MetLife, Inc.:
100,000 6.50% Pfd., Series B ...................................................................... $ 2,221,250*
$ 1,250,000 10.75% 08/01/39 ........................................................................... 1,503,657(1)
Principal Financial Group:
5,000 5.563% Pfd., Series A ..................................................................... 346,719*
100,000 6.518% Pfd., Series B ..................................................................... 1,926,250*(1)
Renaissancere Holdings Ltd.:
122,250 6.08% Pfd., Series C ...................................................................... 2,314,193**(1)(2)
10,700 7.30% Pfd., Series B ...................................................................... 248,909**(2)
119,500 Scottish Re Group Ltd., 7.25% Pfd. ........................................................... 515,344**(2)+
$ 750,000 USF&G Capital, 8.312% 07/01/46, 144A**** ..................................................... 719,934(1)
$ 1,500,000 XL Capital Ltd., 6.50%, Series E ............................................................. 1,102,500(1)(2)
------------
31,666,265
------------
UTILITIES -- 26.2%
10,000 Baltimore Gas & Electric Company, 6.70% Pfd., Series 1993 .................................... 946,250*(1)
2,780 Central Vermont Public Service Corporation, 8.30% Sinking Fund Pfd., Pvt. .................... 279,529*
$ 2,491,000 COMED Financing III, 6.35% 03/15/33 .......................................................... 1,943,979(1)
Dominion Resources, Inc.:
$ 3,500,000 7.50% ..................................................................................... 3,451,903(1)
90,000 8.375% Pfd., Series A ..................................................................... 2,490,300(1)
40,000 Entergy Arkansas, Inc., 6.45% Pfd. ........................................................... 848,752*(1)
Georgia Power Company:
12,600 6.125% Pfd. ............................................................................... 317,048*(1)
12,500 6.50% Pfd., Series 2007A .................................................................. 1,256,641*(1)
3,000 Gulf Power Company, 6.45% Pfd., Series 2007A ................................................. 294,569*(1)
32,650 Indianapolis Power & Light Company, 5.65% Pfd. ............................................... 2,739,541*
170,900 Interstate Power & Light Company, 8.375% Pfd., Series B ...................................... 4,744,611*(1)
Pacific Enterprises:
22,430 $4.50 Pfd. ................................................................................ 1,742,531*(1)
10,000 $4.75 Pfd., Series 53 ..................................................................... 813,125*(1)
$ 500,000 PECO Energy Capital Trust III, 7.38% 04/06/28, Series D ...................................... 424,860(1)
$ 4,400,000 Puget Sound Energy, Inc., 6.974% 06/01/67 .................................................... 3,888,016(1)
60,000 Scana Corporation, 7.70% Pfd. ................................................................ 1,512,000
Southern California Edison:
35,000 6.00% Pfd., Series C ...................................................................... 3,159,846*(1)
11,500 6.125% Pfd. ............................................................................... 1,060,875*(1)
The accompanying notes are an integral part of the financial statements.
15
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2009
SHARES/$ PAR VALUE
------------ ------------
PREFERRED SECURITIES -- (CONTINUED)
UTILITIES -- (CONTINUED)
$ 3,000,000 Southern Union Company, 7.20% 11/01/66 ....................................................... $ 2,505,000(1)
$ 750,000 TXU Electric Capital V, 8.175% 01/30/37 ...................................................... 226,875
18,800 Union Electric Company, $7.64 Pfd. ........................................................... 1,879,413*(1)
$ 3,900,000 Wisconsin Energy Corporation, 6.25% 05/15/67 ................................................. 3,446,687(1)
14,750 Xcel Energy, Inc., $4.08 Pfd., Series B ...................................................... 1,045,775*
------------
41,018,126
------------
ENERGY -- 6.4%
$ 4,700,000 Enbridge Energy Partners LP, 8.05% 10/01/37 .................................................. 4,471,312(1)
Enterprise Products Partners:
$ 750,000 7.00% 06/01/67 ............................................................................ 665,838
$ 1,500,000 8.375% 08/01/66, Series A ................................................................. 1,462,450(1)
3,500 Kinder Morgan GP, Inc., 8.33% Pfd., 144A**** ................................................. 3,430,219*
------------
10,029,819
------------
MISCELLANEOUS INDUSTRIES -- 1.7%
40,000 Ocean Spray Cranberries, Inc., 6.25% Pfd., 144A**** .......................................... 2,611,252*(1)
------------
2,611,252
------------
TOTAL PREFERRED SECURITIES
(Cost $160,096,758) ....................................................................... 149,789,583
------------
CORPORATE DEBT SECURITIES -- 2.8%
FINANCIAL SERVICES -- 0.2%
10,000 Ameriprise Financial, Inc., 7.75% 06/15/39 ................................................... 247,825(1)
------------
247,825
------------
INSURANCE -- 2.3%
$ 2,200,000 Liberty Mutual Insurance, 7.697% 10/15/97, 144A**** .......................................... 1,845,367(1)
$ 2,000,000 UnumProvident Corporation, 7.25% 03/15/28, Senior Notes ...................................... 1,724,340(1)
------------
3,569,707
------------
The accompanying notes are an integral part of the financial statements.
16
Flaherty & Crumrine Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2009
SHARES/$ PAR VALUE
------------ ------------
CORPORATE DEBT SECURITIES -- (CONTINUED)
UTILITIES -- 0.3%
20,000 Entergy Texas, Inc., 7.875% 06/01/39 .............................................. $ 534,200
534,200
------------
TOTAL CORPORATE DEBT SECURITIES
(Cost $3,941,492) .............................................................. 4,351,732
------------
MONEY MARKET FUND -- 0.3%
526,348 BlackRock Provident Institutional, T-Fund ......................................... 526,348
------------
TOTAL MONEY MARKET FUND
(Cost $526,348) ................................................................ 526,348
------------
TOTAL INVESTMENTS (Cost $164,564,598***) ......................................................... 98.8% 154,667,663
OTHER ASSETS AND LIABILITIES (Net) ............................................................... 1.2% 1,896,458
----- ------------
NET ASSETS BEFORE LOAN ........................................................................... 100.0%+++ $156,564,121
----- ------------
LOAN PRINCIPLE BALANCE ........................................................................... (51,800,000)
------------
TOTAL NET ASSETS AVAILABLE TO COMMON STOCK ....................................................... $104,764,121
============
----------
* 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, 2009, these
securities amounted to $28,212,899 or 18.0% of net assets. These securities
have been determined to be liquid under the guidelines established by the
Board of Directors.
(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 $117,899,596 at
November 30, 2009.
(2) Foreign Issuer.
+ 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.
17
Flaherty & Crumrine Preferred Income Fund Incorporated
STATEMENT OF ASSETS AND LIABILITIES
NOVEMBER 30, 2009
ASSETS:
Investments, at value (Cost $164,564,598) .................. $154,667,663
Dividends and interest receivable .......................... 2,058,506
Prepaid expenses. .......................................... 224,688
------------
Total Assets. ........................................... 156,950,857
LIABILITIES:
Loan Payable ............................................... $51,800,000
Dividends payable to Common Stock Shareholders ............. 61,705
Investment advisory fees payable ........................... 74,367
Administration, Transfer Agent and Custodian fees payable .. 23,101
Audit fees payable ......................................... 52,100
Legal fees payable ......................................... 18,382
Directors' fees payable .................................... 1,342
Accrued expenses and other payables ........................ 23,449
Accumulated undeclared distributions to Auction Preferred
Stock Shareholders ...................................... 132,290
-----------
Total Liabilities. ...................................... 52,186,736
------------
NET ASSETS AVAILABLE TO COMMON STOCK .......................... $104,764,121
============
NET ASSETS AVAILABLE TO COMMON STOCK consist of:
Undistributed net investment income ........................ $ 31,856
Accumulated net realized loss on investments sold. ......... (37,616,281)
Unrealized depreciation of investments ..................... (9,896,935)
Par value of Common Stock. ................................. 106,713
Paid-in capital in excess of par value of Common Stock 152,138,768
------------
Total Net Assets Available to Common Stock. ............. $104,764,121
============
NET ASSET VALUE PER SHARE OF COMMON STOCK:
Common Stock (10,671,285 shares outstanding) ............... $ 9.82
============
The accompanying notes are an integral part of the financial statements.
18
Flaherty & Crumrine Preferred Income Fund Incorporated
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED NOVEMBER 30, 2009
INVESTMENT INCOME:
Dividends+. ................................................ $ 5,968,116
Interest ................................................... 5,659,759
------------
Total Investment Income. ................................ 11,627,875
EXPENSES:
Investment advisory fees ................................... $ 754,419
Administrator's fees. ...................................... 130,496
Auction Preferred Stock broker commissions and auction
agent fees .............................................. 81,535
Audit fees ................................................. 60,900
Legal fees ................................................. 98,917
Insurance expenses ......................................... 126,471
Transfer Agent fees ........................................ 52,038
Directors' fees ............................................ 65,886
Custodian fees ............................................. 25,280
Compliance fees ............................................ 37,785
Interest expense ........................................... 310,069
Other ...................................................... 149,690
-----------
Total Expenses .......................................... 1,893,486
------------
NET INVESTMENT INCOME ......................................... 9,734,389
------------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
Net realized loss on investments sold during the year ...... (15,921,276)
Change in net unrealized appreciation/depreciation of
investments . ........................................... 56,189,433
------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS. .............. 40,268,157
------------
DISTRIBUTIONS TO AUCTION PREFERRED STOCK SHAREHOLDERS:
From net investment income (including changes in accumulated
undeclared distributions) ............................... (1,041,660)
------------
NET INCREASE IN NET ASSETS TO COMMON STOCK
RESULTING FROM OPERATIONS ..................................... $ 48,960,886
============
----------
+ 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.
19
Flaherty & Crumrine Preferred Income Fund Incorporated
STATEMENTS OF CHANGES IN NET ASSETS AVAILABLE TO COMMON STOCK
YEAR ENDED YEAR ENDED
NOVEMBER 30, 2009 NOVEMBER 30, 2008
----------------- -----------------
OPERATIONS:
Net investment income ............................................... $ 9,734,389 $ 13,492,692
Net realized loss on investments sold during the year ............... (15,921,276) (18,269,870)
Change in net unrealized appreciation/depreciation of investments ... 56,189,433 (53,709,204)
Distributions to APS* Shareholders from net investment income,
including changes in accumulated undeclared distributions ........ (1,041,660) (4,493,991)
------------ ------------
NET INCREASE/(DECREASE) IN NET ASSETS RESULTING FROM
OPERATIONS ....................................................... 48,960,886 (62,980,373)
DISTRIBUTIONS:
Dividends paid from net investment income to Common Stock
Shareholders(1) .................................................. (8,040,825) (9,155,620)
Tax return of capital to Common Stock Shareholders .................. -- (556,396)
------------ ------------
TOTAL DISTRIBUTIONS TO COMMON STOCK SHAREHOLDERS .................... (8,040,825) (9,712,016)
FUND SHARE TRANSACTIONS:
Increase from shares issued under the Dividend Reinvestment
and Cash Purchase Plan ........................................... 566,685 415,249
------------ ------------
NET INCREASE IN NET ASSETS AVAILABLE TO COMMON STOCK RESULTING
FROM FUND SHARE TRANSACTIONS ..................................... 566,685 415,249
------------ ------------
NET INCREASE/(DECREASE) IN NET ASSETS AVAILABLE TO
COMMON STOCK FOR THE YEAR ........................................ $ 41,486,746 $(72,277,140)
============ ============
NET ASSETS AVAILABLE TO COMMON STOCK:
Beginning of year ................................................... $ 63,277,375 $135,554,515
Net increase/(decrease) in net assets during the year ............... 41,486,746 (72,277,140)
------------ ------------
End of year (including undistributed net investment income of
$31,856 and distributions in excess of net investment income of
$(882,350), respectively) ........................................ $104,764,121 $ 63,277,375
============ ============
----------
* 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.
20
Flaherty & Crumrine Preferred Income Fund Incorporated
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED NOVEMBER 30, 2009
INCREASE/(DECREASE) IN CASH
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase in net assets resulting from operations ..................... $ 48,960,886
ADJUSTMENTS TO RECONCILE NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS TO NET CASH USED IN OPERATING ACTIVITIES:
Purchase of investment securities ........................................ (77,492,564)
Proceeds from disposition of investment securities ....................... 66,546,567
Sale of short-term investment securities, net. ........................... 10,934,424
Return of capital received from investments in preferred stock ........... 667,231
Cash received from bankruptcy claim ...................................... 1,750,466
Increase in dividends and interest receivable ............................ (467,664)
Decrease in receivable for investments sold .............................. 807,400
Increase in prepaid expenses ............................................. (154,753)
Net amortization/(accretion) of premium/(discount) ....................... (228,357)
Decrease in accrued expenses and other liabilities ....................... (18,721)
Unrealized appreciation on securities .................................... (56,189,433)
Net realized loss from investments ....................................... 15,921,276
------------
Net cash provided in operating activities ............................. 11,036,758
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from loan ....................................................... 51,800,000
Proceeds from shares reinvested. ......................................... 566,685
Redemption of Auction Preferred Stock (APS) .............................. (54,800,000)
Decrease in payable for APS .............................................. (551,120)
Decrease in dividend payable to common stock shareholders ................ (11,498)
Distributions to common stock shareholders from net investment income .... (8,040,825)
------------
Net cash used by financing activities ................................. (11,036,758)
------------
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 ............................................ 302,107
------------
The accompanying notes are an integral part of the financial statements.
21
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,
-----------------------------------------------------
2009 2008 2007 2006 2005
--------- --------- ---------- --------- --------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year ......................................... $ 5.98 $ 12.85 $ 15.80 $ 15.26 $ 15.49
-------- -------- -------- -------- --------
INVESTMENT OPERATIONS:
Net investment income ...................................................... 0.92 1.27 1.35 1.29 1.22
Net realized and unrealized gain/(loss) on investments ..................... 3.78 (6.80) (2.90) 0.62 (0.07)
DISTRIBUTIONS TO APS* SHAREHOLDERS:
From net investment income ................................................. (0.10) (0.42) (0.37) (0.32) (0.21)
-------- -------- -------- -------- --------
Total from investment operations ........................................... 4.60 (5.95) (1.92) 1.59 0.94
-------- -------- -------- -------- --------
DISTRIBUTIONS TO COMMON STOCK SHAREHOLDERS:
From net investment income ................................................. (0.76) (0.87) (1.03) (1.05) (1.17)
From return of capital ..................................................... -- (0.05) -- -- --
-------- -------- -------- -------- --------
Total distributions to Common Stock Shareholders ........................... (0.76) (0.92) (1.03) (1.05) (1.17)
-------- -------- -------- -------- --------
Net asset value, end of year ............................................... $ 9.82 $ 5.98 $ 12.85 $ 15.80 $ 15.26
======== ======== ======== ========= ========
Market value, end of year .................................................. $ 9.12 $ 5.67 $ 12.41 $ 16.98 $ 16.44
Total investment return based on net asset value** ......................... 82.53% (48.39%) (12.90%) 10.74% 5.78%
Total investment return based on market value** ............................ 78.78% (49.34%) (21.73%) 10.47% 1.33%
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK SHAREHOLDERS:
Total net assets, end of year (in 000's) ................................ $104,764 $ 63,277 $135,555 $165,475 $158,277
Operating expenses including interest expense(1) ........................ 2.44% -- -- -- --
Operating expenses excluding interest expense ........................... 2.04% 1.99% 1.49% 1.49% 1.48%
Net investment income + ................................................. 12.55% -- -- -- --
Net investment income, including payments to APS Shareholders + ......... 11.21% 8.38% 6.57% 6.39% 6.38%
SUPPLEMENTAL DATA: ++
Portfolio turnover rate ................................................. 56% 67% 59% 71% 54%
Net assets before loan, end of year (in 000's) .......................... $156,564 $118,077 $215,555 $245,475 $238,277
Ratio of operating expenses including interest expense(1)(2) to net
assets before loan and APS ........................................... 1.50% -- -- -- --
Ratio of operating expenses excluding interest expense(2) to net assets
before loan and APS .................................................. 1.25% 1.15% 0.99% 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 7.
(2) Does not include distributions to APS shareholders.
The accompanying notes are an integral part of the financial statements.
22
Flaherty & Crumrine Preferred Income Fund Incorporated
FINANCIAL HIGHLIGHTS (CONTINUED)
PER SHARE OF COMMON STOCK (UNAUDITED)
TOTAL DIVIDEND
DIVIDENDS NET ASSET NYSE REINVESTMENT
PAID VALUE CLOSING PRICE PRICE (1)
--------- --------- ------------- ------------
December 31, 2008 ........... $0.0630 $6.50 $5.90 $6.54
January 30, 2009 ............ 0.0630 6.08 7.05 6.70
February 27, 2009 ........... 0.0630 5.11 5.43 5.16
March 31, 2009 .............. 0.0630 5.30 5.50 5.30
April 30, 2009 .............. 0.0630 5.81 6.02 5.81
May 29, 2009 ................ 0.0630 7.18 7.35 7.18
June 30, 2009 ............... 0.0630 7.64 8.00 7.64
July 31, 2009 ............... 0.0630 8.18 8.11 8.20
August 31, 2009 ............. 0.0630 8.73 8.50 8.60
September 30, 2009 .......... 0.0630 9.37 9.40 9.37
October 30, 2009 ............ 0.0630 9.72 9.03 9.24
November 30, 2009 ........... 0.0630 9.82 9.12 9.40
----------
(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.
23
Flaherty & Crumrine Preferred Income Fund Incorporated
FINANCIAL HIGHLIGHTS (CONTINUED)
The table below sets out information with respect to Auction Preferred
Stock outstanding.
INVOLUNTARY
ASSET LIQUIDATION
TOTAL SHARES COVERAGE PREFERENCE
DATE OUTSTANDING (1) PER SHARE (2) PER SHARE (3)
-------- --------------- ------------- -------------
11/30/09 -- N/A N/A
11/30/08 548 $216,717 $100,000
11/30/07 800 270,586 100,000
11/30/06 800 307,433 100,000
11/30/05 800 298,367 100,000
----------
(1) See note 6.
(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.
The accompanying notes are an integral part of the financial statements.
24
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. It is determined in accordance with
policies and procedures approved by the Board of Directors of the Fund 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.
25
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. A
summary of the inputs used to value the Fund's investments as of November 30,
2009 is as follows:
LEVEL 2 LEVEL 3
TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
NOVEMBER 30, 2009 PRICE INPUTS INPUTS
----------------- ------------ ----------- ------------
Preferred Securities
Banking $63,813,435 $42,628,999 $21,134,936 $49,500
Financial Services 650,686 629,295 21,391 --
Insurance 31,666,265 13,558,420 18,107,845 --
Utilities 41,018,126 12,515,862 28,502,264 --
Energy 10,029,819 -- 10,029,819 --
Miscellaneous Industries 2,611,252 -- 2,611,252 --
Corporate Debt Securities 4,351,732 782,025 3,569,707 --
Money Market Fund 526,348 526,348 -- --
------------ ------------ ------------ -------
Total Investments $154,667,663 $70,640,949 $83,977,214 $49,500
============ ============ ============ =======
26
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Following is a reconciliation of Level 3 investments for which significant
unobservable inputs were used to determine fair value:
PREFERRED
TOTAL SECURITIES
INVESTMENTS BANKING
----------- -----------
BALANCE AS OF 11/30/08 ........................... $ -- $ --
Accrued discounts/premiums ....................... -- --
Realized gain/(loss) ............................. -- --
Change in unrealized appreciation/(depreciation).. (4,675,500) (4,675,500)
Net purchases/(sales) ............................ -- --
Transfers in and/or out of Level 3 ............... 4,725,000 4,725,000
----------- -----------
BALANCE AS OF 11/30/09 ........................... $ 49,500 $ 49,500
For the year ended November 30, 2009, total change in unrealized
gain/(loss) on Level 3 securities still held at year end and included in the
change in net assets was $(4,675,500). 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: In the normal course of pursuing its investment objectives, the
Fund is subject to interest rate risk and may purchase or write options to hedge
against this risk. 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. The risks associated with
purchasing options and the maximum loss the Fund would incur are limited to the
purchase price originally paid.
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.
27
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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. There were no purchased or written options for the year
ended November 30, 2009.
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 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, 2009, 2008, 2007 and 2006), 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.
28
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 2009 and 2008 was as follows:
DISTRIBUTIONS PAID IN DISTRIBUTIONS PAID IN
FISCAL YEAR 2009 FISCAL YEAR 2008
-------------------------- --------------------------------------
ORDINARY LONG-TERM ORDINARY LONG-TERM RETURN OF
INCOME CAPITAL GAINS INCOME CAPITAL GAINS CAPITAL
---------- ------------- ---------- ------------- ---------
Common $8,040,825 $0 $9,155,620 $0 $556,396
Preferred $1,041,660 $0 $4,493,991 $0 $ 0
As of November 30, 2009, the components of distributable earnings (i.e.,
ordinary income and capital gain/loss) available to Common and Preferred Stock
Shareholders, on a tax basis, were as follows:
CAPITAL (LOSS) UNDISTRIBUTED UNDISTRIBUTED NET UNREALIZED
CARRYFORWARD ORDINARY INCOME LONG-TERM GAIN APPRECIATION/(DEPRECIATION)
-------------- --------------- -------------- ---------------------------
$(37,653,508) $436,155 $0 $(9,894,364)
At November 30, 2009, the composition of the Fund's $37,653,508 accumulated
realized capital losses was $778,250, $2,761,487, $18,185,622 and $15,928,149
incurred in 2004, 2007, 2008 and 2009, respectively. These losses may be carried
forward and offset against any future capital gains through 2012, 2015, 2016 and
2017, respectively.
RECLASSIFICATION OF ACCOUNTS: During the year ended November 30, 2009,
reclassifications were made in the Fund's capital accounts to report these
balances on a tax basis, excluding temporary differences, as of November 30,
2009. 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
--------- --------------------- ------------------------
$(501,074) $262,302 $238,772
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.
29
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. 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.
PNC Global Investment Servicing (U.S.) Inc. ("PNC") serves as the Fund's
Administrator. As Administrator, PNC 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 PNC's services
as Administrator, the Fund pays PNC a monthly fee at an annual rate of 0.10% of
the first $200 million of the Fund's average 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.
PNC also serves as the Fund's Common Stock dividend-paying agent and
registrar (Transfer Agent). As compensation for PNC's services, the Fund pays
PNC 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.
PFPC Trust Company ("PFPC Trust") serves as the Fund's custodian. PFPC
Trust is an indirect subsidiary of PNC Financial Services. 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 $500 for each in-person
meeting of the Board of Directors or any committee and $150 for each telephone
meeting. The Audit Committee Chairman receives an additional annual fee of
$2,500. The Fund also reimburses all Directors for travel and out-of-pocket
expenses incurred in connection with such meetings.
30
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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.
4. PURCHASES AND SALES OF SECURITIES
For the year ended November 30, 2009, the cost of purchases and proceeds
from sales of securities excluding short-term investments, aggregated
$77,492,564 and $66,546,567, respectively.
At November 30, 2009, the aggregate cost of securities for federal income
tax purposes was $164,562,027, the aggregate gross unrealized appreciation for
all securities in which there is an excess of value over tax cost was
$17,445,510 and the aggregate gross unrealized depreciation for all securities
in which there is an excess of tax cost over value was $27,339,874.
5. COMMON STOCK
At November 30, 2009, 240,000,000 shares of $0.01 par value Common Stock
were authorized.
Common Stock transactions were as follows:
YEAR ENDED YEAR ENDED
11/30/09 11/30/08
----------------- -----------------
SHARES AMOUNT SHARES AMOUNT
------ -------- ------ --------
Shares issued under the Dividend Reinvestment
and Cash Purchase Plan ................... 85,637 $566,685 39,898 $415,249
6. 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.
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 7) 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.
31
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. 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 6), 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. On August 28, 2009, the Financing Agreement was
amended to allow for changes in the committed amount. As of November 30, 2009,
the committed amount, and amount borrowed under the Financing Agreement was
$51.8 million.
Under the terms of the Financing Agreement, the lender charges an
annualized rate of 1.00% on the undrawn (committed) balance, and Three-Month
London Interbank Offered Rate (LIBOR) - reset every three months - PLUS 1.10% on
the drawn (borrowed) balance. For the period beginning on July 14, 2009 (initial
use of the facility) and ending on November 30, 2009, the daily weighted average
annualized interest rate on the drawn balance was 1.564% and the average daily
loan balance was $48,061,538. 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 will be amortized to expense over a period of
eighteen months, unless accelerated due to the termination of the Financing
Agreement. If the Fund elects to renew the Financing Agreement, a renewal fee
equal to 0.50% of the then-committed amount shall be paid to the lender on each
540th calendar day following the date of the original Financing Agreement. 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.
8. 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
32
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 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.
9. SPECIAL INVESTMENT TECHNIQUES
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. Such transactions may expose the Fund to credit and market
valuation risk greater than that associated with regular trade settlement
procedures. The Fund may also enter into transactions, in accordance with its
investment policies, involving any or all of the following: short sales of
securities, purchases of securities on margin, futures contracts, interest rate
swaps, swap futures, options on futures contracts, options on securities,
swaptions and certain credit derivative transactions, including, but not limited
to, the purchase and sale of credit protection. As in the case of when-issued
securities, the use of over-the-counter derivatives, such as interest rate
swaps, swaptions, and credit default swaps may expose the Fund to greater
credit, operations, liquidity, and valuation risk than is the case with
regulated, exchange traded futures and options. These transactions are used for
hedging or other appropriate risk-management purposes, or, under certain other
circumstances, to increase return. No assurance can be given that such
transactions will achieve their desired purposes or will result in an overall
reduction of risk to the Fund.
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
33
Flaherty & Crumrine Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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, 2009, 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 January 21, 2010, the date the financial statements were issued, and has
determined that there were no subsequent events requiring recognition or
disclosure in the financial statements.
34
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, 2009, 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, 2009 by correspondence with
the custodian. 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, 2009,
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.
(KPMG LLP)
Boston, Massachusetts
January 21, 2010
35
Flaherty & Crumrine Preferred Income Fund Incorporated
SUPPLEMENTARY TAX INFORMATION (UNAUDITED)
Distributions to Common Stock and Auction Preferred Stock (APS)
shareholders are characterized as follows for purposes of Federal income taxes
(as a percentage of total distributions):
FISCAL YEAR 2009
INDIVIDUAL SHAREHOLDER CORPORATE SHAREHOLDER
----------------------- ---------------------
ORDINARY ORDINARY
QDI INCOME DRD INCOME
------- -------------- ------- ------------
APS and Common Stock 55.65% 44.35% 40.39% 59.61%
CALENDAR YEAR 2009
INDIVIDUAL SHAREHOLDER CORPORATE SHAREHOLDER
---------------------- ---------------------
ORDINARY ORDINARY
QDI INCOME DRD INCOME
------ ------------- ------ ------------
APS 55.65% 44.35% 40.39% 59.61%
Common Stock 53.96% 46.04% 37.41% 62.59%
Qualified Dividend Income ("QDI") distributions are taxable at a maximum
15% personal tax rate.
SECTION 19 NOTICES
Section 19 of the 1940 Act requires registered investment companies to
include a notice with the payment of a dividend if a portion of that dividend
may come from sources other than undistributed net income (other sources could
include realized gains from the sale of securities and non-taxable return of
capital). Copies of the Section 19 notices for the Fund are available on the
website at www.preferredincome.com.
Form 1099-DIV will be sent to shareholders in January 2010 reporting the
amount and tax characterization of distributions for the 2009 calendar year.
36
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 PNC 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, PNC 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 PNC 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, PNC 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 PNC's open
market purchases in connection with the reinvestment of dividends or capital
gains distributions. For the year ended November 30, 2009, $1,019 in 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.
37
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 PNC 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 PNC in writing, by
completing the form on the back of the Plan account statement and forwarding it
to PNC, or by calling PNC directly. A termination will be effective immediately
if notice is received by PNC 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, PNC 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 PNC at 1-800-331-1710.
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 21, 2009. 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 1-800-331-1710 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, 2009. 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.
38
Flaherty & Crumrine Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
CERTIFICATIONS
Included in the Annual Written Affirmation submitted to the NYSE, Donald F.
Crumrine, as the Fund's Chief Executive Officer, has certified that, as of May
16, 2009, he was not aware of any violation by the Fund of applicable NYSE
corporate governance listing standards. The Fund's reports to the SEC on Forms
N-CSR and N-Q contain certifications by the Fund's principal executive officer
and principal financial officer that relate to the Fund's disclosure in such
reports and that are required by Rule 30a-2(a) under the 1940 Act.
39
Flaherty & Crumrine Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
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
POSITION(S) AND LENGTH OF DURING PAST OVERSEEN OTHER DIRECTORSHIPS
NAME, ADDRESS, 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 1920
San Francisco, CA 94104
Age: 60
MORGAN GUST Director Class III Director Owner and operator of 4 CoBiz, Financial,
301 E. Colorado Boulevard since various entities Inc. (financial
Suite 720 January 1991 engaged in agriculture services)
Pasadena, CA 91101 and real estate; Former
Age: 62 President of Giant
Industries, Inc.
(petroleum refining and
marketing) from March
2002 through June 2007
KAREN H. HOGAN+ Director Class I Director Active Committee Member 4
301 E. Colorado Boulevard since and Volunteer to
Suite 720 April 2005 several non-profit
Pasadena, CA 91101 organizations; from
Age: 48 September 1985 to
January 1997, Senior
Vice President of
Preferred Stock
Origination at Lehman
Brothers and
Previously, Vice
President of New
Product Development
-----------
* 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 2010 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.
40
Flaherty & Crumrine Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
PRINCIPAL NUMBER OF FUNDS
TERM OF OFFICE OCCUPATION(S) IN FUND COMPLEX
POSITION(S) AND LENGTH OF DURING PAST OVERSEEN OTHER DIRECTORSHIPS
NAME, ADDRESS, AND AGE HELD WITH FUND TIME SERVED* FIVE YEARS BY DIRECTOR HELD BY DIRECTOR**
---------------------- -------------- ------------------ ----------------------- --------------- -------------------
NON-INTERESTED DIRECTORS:
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: 72 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
Suite 720 the Board and January 1991 Flaherty & Crumrine
Pasadena, CA 91101 Chief Incorporated
Age: 62 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 2010 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.
41
Flaherty & Crumrine Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
PRINCIPAL
TERM OF OFFICE OCCUPATION(S)
POSITION(S) AND LENGTH OF DURING PAST
NAME, ADDRESS, 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: 51
R. ERIC CHADWICK Chief Financial Since Director of Flaherty & Crumrine
301 E. Colorado Boulevard Officer, Vice July 2004 Incorporated since June 2006; Vice
Suite 720 President and President of Flaherty & Crumrine
Pasadena, CA 91101 Treasurer Incorporated
Age: 34
CHAD C. CONWELL Chief Compliance Since Chief Compliance Officer of Flaherty
301 E. Colorado Boulevard Officer, Vice July 2005 & Crumrine Incorporated since
Suite 720 President and September 2005; Vice President of
Pasadena, CA 91101 Secretary Flaherty & Crumrine Incorporated
Age: 37 since July 2005; Attorney with Paul,
Hastings, Janofsky & Walker LLP from
September 1998 to June 2005
BRADFORD S. STONE Vice President Since Director of Flaherty & Crumrine
47 Maple Street and Assistant July 2003 Incorporated since June 2006; Vice
Suite 403 Treasurer President of Flaherty & Crumrine
Summit, NJ 07901 Incorporated
Age: 50
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: 46 Assistant Secretary
42
[This page intentionally left blank]
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
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 --
PNC Global Investment Servicing
(U.S.) Inc.
P.O. Box 43027
Providence, RI 02940-3027
1-800-331-1710
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 LOGO)
PREFERRED INCOME FUND
Annual
Report
November 30, 2009
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 2009 and $44,000 for 2008.
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 2009 and $0 for 2008.
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 2009 and
$8,100 for 2008.
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
$8,600 for 2009 and $17,200 for 2008. 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 2009 and $0 for 2008.
(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 Flaherty & Crumrine Investment Grade Fixed
"Canadian Fund" 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, 2009:
# of Accounts
Managed for
which
Total Advisory Fee
Name of Portfolio # of Accounts Total is Based on
Manager or Team Member Type of Accounts Managed Assets (mm) Performance
---------------------- -------------------------------------- ------------- ----------- -------------
1. Donald F. Crumrine Other Registered Investment Companies: 3 1,205 0
Other Pooled Investment Vehicles: 1 163 0
Other Accounts: 15 1,634 0
2. Robert M. Ettinger Other Registered Investment Companies: 3 1,205 0
Other Pooled Investment Vehicles: 1 163 0
Other Accounts: 15 1,634 0
3. R. Eric Chadwick Other Registered Investment Companies: 3 1,205 0
Other Pooled Investment Vehicles: 1 163 0
Other Accounts: 15 1,634 0
4. Bradford S. Stone Other Registered Investment Companies: 3 1,205 0
Other Pooled Investment Vehicles: 1 163 0
Other Accounts: 15 1,634 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, 2009:
Dollar Range of Fund
Name Shares 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 $50,001 to $100,000
* 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, 2010
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, 2010
By (Signature and Title)* /s/ R. Eric Chadwick
----------------------------------------
R. Eric Chadwick, Chief Financial
Officer, Treasurer, and Vice President
(principal financial officer)
Date January 26, 2010
* Print the name and title of each signing officer under his or her
signature.