<PAGE>
PREFERRED INCOME FUND
INCORPORATED
Dear Shareholder:
The Preferred Income Fund had good results in its fiscal first half ended
May 31, 1997, despite market conditions that were generally difficult for bond
investors. Total return on net asset value ("NAV") was 5.2% for the six months.
The return on market price was 6.9%. This was slightly better as the discount of
market from NAV narrowed further to approximately 4.6% at the end of our first
half.
The Preferred Income Fund is intended to be an alternative to higher quality
bond funds for investors who want less exposure to fluctuating interest rates
than is normally associated with fixed income investments. As the following
table shows, it has proven to be a very good alternative. The Fund has
outperformed, over time, almost all the funds in a group of up to 60 higher
quality closed-end bond funds compiled by Lipper Analytical Services, Inc.
<TABLE>
<S> <C> <C> <C>
TOTAL RETURNS EARNED ON NET ASSET VALUE
THROUGH MAY 31, 1997
ONE YEAR TWO YEARS THREE YEARS
----------- ------------- ---------------
PREFERRED INCOME FUND 14.9% 12.8% 11.3%
RANK VS. HIGHER QUALITY BOND FUNDS #3 OF 60 #5 OF 60 #3 OF 38
</TABLE>
Source: Lipper Analytical Services, Inc. The comparison group includes all
U.S. Government bond, mortgage bond and term trust, and investment grade
bond funds in Lipper's closed-end fund database.
The Fund's performance has been aided recently by a bit of a tail wind.
There has been a steady stream of redemptions of traditional preferred stocks,
motivated by the tax benefits to issuers of refinancing with new forms of hybrid
preferreds. As a result, preferred stocks eligible for the Dividends Received
Deduction ("DRD") have become increasingly scarce, and their prices have been
quite firm. Such issues make up the bulk of the Fund's portfolio.
As the prices of preferred stocks eligible for the DRD strengthened, we
whittled down the Fund's holdings of such issues. The net reduction was focused
on fixed rate preferreds, which now account for about 42% of the portfolio, down
from 64% the year before. Adjustable rate preferreds ("ARPs"), which seemed
rather cheap at times last year, were increased to approximately 39% of the
portfolio, compared to 29% twelve months earlier. This was good move since ARPs
proved to be the Fund's star performers.
<PAGE>
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
PORTFOLIO COMPOSITION AS OF
<S> <C>
5/31/97
Adjustable Rates 39%
Non-DRD Preferreds 16%
Traditional Fixed Rates 42%
Cash & Other 3%
</TABLE>
The cash from the net sales of preferreds eligible for the DRD was used to
increase the Fund's holdings of hybrid preferreds to approximately 16% of the
portfolio, compared to 3% last year at this time. Most of the increase has
occurred since the Federal Reserve Board's approval last October of the issuance
of hybrids by banks. A surge of new issues of hybrids resulted from that action,
which has produced more attractive yields for investors.
The Question and Answer section that follows this letter goes into greater
detail concerning the scarcity of traditional preferreds and the expanded role
of hybrid preferreds in the Fund's portfolio.
The Board of Directors of the Fund recently authorized the Fund to invest up
to 15% of its assets in common stocks. The Fund's two sister funds have had this
latitude since their inceptions, and it has been useful. From time to time, we
see high yielding common stocks that are attractive alternatives to preferred
stocks. The Preferred Income Fund will now be able to take advantage of such
situations.
The uncertainty about the tax laws that has been hanging over the preferred
stock market may be starting to clear up a bit. As previously discussed in these
letters, the Clinton Administration has proposed reducing and otherwise
curtailing the DRD and also restricting hybrid preferreds in a number of ways.
The recent budget agreement appears to put much of the responsibility for the
details of the necessary tax legislation back in the hands of Congress. We are
encouraged that the tax bill unveiled this June by the Chairman of the House
Committee on Ways & Means does not contain any of the proposals that we
previously found most disturbing. Just remember, in Washington, "It ain't over
'til it's over."
On balance, the Fund's hedges have slightly reduced the returns earned in
the current fiscal year to date. Although interest rates are up since the start
of the year, they have not increased far enough or fast enough to overcome the
cost of the hedge. The hedges did, however, help the stability of NAV as
interest rates bounced around. This is similar to an insurance policy that costs
you money but helps you sleep better.
Although many of our shareholders participate in the Fund's Dividend
Reinvestment Plan, unceremoniously labeled the "DRIP," we suspect there are
others who may have overlooked this opportunity. The DRIP
2
<PAGE>
allows shareholders to acquire additional shares of the Fund on a regular basis
at very economical transaction costs and, in the current market, a discount from
NAV. (See pages 22-23 of this report for a detailed description of the DRIP.)
Information about the plan is available through the Fund's Shareholder Servicing
Agent, First Data Investor Services Group, Inc. at 1-800-331-1710.
Sincerely,
[SIG]
Robert T. Flaherty
CHAIRMAN OF THE BOARD
June 10, 1997
3
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
QUESTION & ANSWER SECTION
MAY 31, 1997 (UNAUDITED)
- -----------------------------------------------
HOW LONG WILL THE SCARCITY OF TRADITIONAL PREFERRED STOCKS LAST?
We do not buy the notion that traditional preferreds, which are eligible for
the Dividends Received Deduction (the "DRD"), will be totally replaced by hybrid
preferreds. Ultimately, the two types of preferreds should coexist in the market
place. As the saying goes, it's just a matter of price.
The current wave of redemptions of DRD eligible traditional preferreds has a
lot of momentum. There are many such preferreds with dividend rates above
current market levels that become redeemable for the first time this year. Many
of the issuers of those traditional preferreds have already come to market with
new hybrid preferreds for the obvious purpose of refinancing in advance their
DRD eligible issues. Because of this, the scarcity of traditional preferreds
will continue for a while and may become even more pronounced in the months
ahead.
On a more basic level, the incentive, including tax benefits, for
corporations to issue hybrids instead of traditional preferreds is gradually
declining. The cost of financing with traditional preferreds has gotten
noticeably cheaper, reflecting stronger prices and lower yields relative to
hybrids. Furthermore, regulatory and credit rating considerations may encourage
companies that already have several issues of hybrids outstanding to consider
financing again with traditional preferreds in the future. Of course, we are
assuming no dramatic change in the tax laws.
It will take time for this situation to shake out completely. New issue
activity in traditional preferreds may recover slowly, but it is difficult to
see in the next year or two any net growth in this sector after retirements. We
expect the prices of traditional preferreds to remain well above what used to be
"normal" as long as the hybrid market is thriving.
WILL THE SCARCITY CAUSE TRADITIONAL PREFERREDS TO CONTINUE OVERPERFORMING
HYBRIDS?
There are limits to everything, even "overperformance" by traditional
preferreds. For a higher rate issue, the price at which it can be redeemed by
the issuer, either now or in the near future, is clearly a barrier on the
upside. Similarly, even a traditional preferred that has a lower dividend rate
or is not redeemable in the near future will eventually lose steam on the
upside. Potentially, the highest bidder for such an issue is the issuer itself
through a stock buyback program. Corporate investors could lose interest in
supporting the market before that happened, however, if the market price rose
enough to discount fully the tax advantage of the DRD. At that point, they would
then be indifferent between owning the traditional preferred or a hybrid.
The potential performance of traditional preferreds varies from case to
case. We have our eyes on the limits described above, even though many issues
have not yet reached them.
4
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
QUESTION & ANSWER SECTION (CONTINUED)
MAY 31, 1997 (UNAUDITED)
-----------------------------------------------
HAS THE FUND'S STRATEGY ON HYBRID PREFERREDS CHANGED?
Market conditions have been changing rapidly, and our strategy on hybrids
has evolved in response to those changes.
When hybrids were first introduced over three years ago, it was easy. As a
new gimmick, hybrids were relatively fully priced, and their yields were not
very tempting. We saw a a possible "creeping scarcity" of preferreds eligible
for the DRD, which made traditional preferreds that much more attractive. Zero
seemed like the right amount of dollars to put into hybrids, and that proved to
be a very good decision.
A little over a year ago, hybrids became more interesting. They were coming
to market so rapidly that bursts of new issues occasionally offered investors
quite attractive yields. The hybrids purchased by the Fund proved to be only
trading opportunities that were typically sold as soon as the market snapped
back. Because of their increasing scarcity, traditional preferreds still seemed
like the best place to be. That was another good decision.
An important "mid-course adjustment" occurred after the Federal Reserve
Board determined last October that, subject to certain limitations, banks could
issue hybrids to satisfy their capital requirements. In the months that
followed, there was a flood of new issues of hybrids that pushed their yields up
to and, in some cases, above the point where they were fully competitive with
other sectors of the fixed income markets. We steadily built the Fund's position
up to about 16% of the portfolio, trading actively along the way the hybrids
that were held. That is where the Fund stands now, and it looks like another
good decision so far.
IS THE FUND LIKELY TO MOVE FURTHER INTO HYBRID PREFERREDS?
The Fund may very well buy more hybrids. It will depend on market
conditions. Ideally, we would like to squeeze the last drop of overperformance
out the Fund's holdings of traditional preferreds. However, we will take
advantage of better opportunities in hybrids, whenever they come along. In
short, we will continue to be comparison shoppers. Some things never change!
HOW DOES THE INCREASE IN THE FUND'S POSITION IN HYBRIDS AFFECT THE PORTION OF
THE FUND'S OWN DIVIDENDS THAT QUALIFIES FOR THE DIVIDENDS RECEIVED DEDUCTION?
It appears as though increasing the Fund's position in hybrids has not had
significant tax consequences up to this point, although the exact numbers will
not be known until the end of the fiscal year on November 30th. This favorable
outcome stems from the intricacies of the tax laws that permit the Fund to
deduct all its expenses against income that is not eligible for the DRD, such as
income from hybrids. However, adding further to our holdings of hybrids probably
would reduce the percentage of the Fund's dividends eligible for the DRD.
5
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
QUESTION & ANSWER SECTION (CONTINUED)
MAY 31, 1997 (UNAUDITED)
- -----------------------------------------------
Although the Fund is no longer managed with a view to maximizing income
eligible for the DRD, the DRD is still important. To the extent that our
distributions do not fully qualify for the DRD, we must make extra "gross up"
payments to holders of the Money Market Cumulative Preferred-TM- Stock that
provides the Fund's leverage. In addition, the DRD increases the appeal of the
Fund's shares to corporate investors and broadens the market for our stock,
which helps all shareholders.
As a rule of thumb, if a traditional DRD eligible preferred is attractive to
corporate investors generally, the Fund will probably be able to make money on
it and get some advantage from the DRD also. If it is not attractive to
corporate holders, who are typically the investors willing to pay the best
price, the Fund probably should not own it either.
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
FINANCIAL DATA
PER SHARE OF COMMON STOCK (UNAUDITED)
- ---------------------------------------
<TABLE>
<CAPTION>
DIVIDEND
DIVIDEND NET ASSET NYSE REINVESTMENT
PAID VALUE CLOSING PRICE PRICE (1)
----------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
December 31, 1996................................................ $ 0.840 $ 15.57 $ 14.750 $ 15.23
January 31, 1997................................................. 0.087 15.46 14.750 14.73
February 28, 1997................................................ 0.087 15.74 14.750 14.88
March 31, 1997................................................... 0.087 15.95 15.125 15.16
April 30, 1997................................................... 0.087 15.84 14.875 14.94
May 31, 1997..................................................... 0.087 15.99 15.250 15.27
</TABLE>
- ------------------------
(1) See ADDITIONAL INFORMATION; Dividend Reinvestment and Cash Purchase Plan on
pages 22 and 23 of this report.
6
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS
MAY 31, 1997 (UNAUDITED)
--------------------------------------------------
<TABLE>
<CAPTION>
VALUE
SHARES (NOTE 1)
- --------- -----------
<C> <S> <C>
PREFERRED STOCKS AND SECURITIES -- 97.8%
ADJUSTABLE RATE PREFERRED STOCKS -- 39.4%
UTILITIES -- 8.7%
24,920 Arizona Public Service Company,
Series Q, Adj. Rate Pfd....... $ 2,342,480
13,636 Entergy Gulf States Utilities
Inc.,
Series A, Adj. Rate Pfd....... 1,315,874
Georgia Power Company:
42,500 Series 1993 K, Adj. Rate
Pfd........................... 1,070,469
14,000 Series 1993-2 L, Adj. Rate
Pfd........................... 337,750
11,140 Gulf Power Company,
Adj. Rate Pfd................. 253,435
52,000 Illinois Power Company,
Series A, Adj. Rate Pfd....... 2,314,000
114,900 New York State Electric & Gas
Corporation,
Series B, Adj. Rate Pfd....... 2,714,512
Niagara Mohawk Power
Corporation:
154,879 Series A, Adj. Rate Pfd....... 3,136,300
32,455 Series B, Adj. Rate Pfd....... 782,977
88,745 Series C, Adj. Rate Pfd....... 2,052,228
Northern States Power Company:
13,550 Series A, Adj. Rate Pfd....... 1,283,862
6,000 Series B, Adj. Rate Pfd....... 568,500
20,800 Puget Sound Power & Light
Company,
Series B, Adj. Rate Pfd....... 497,900
-----------
TOTAL UTILITY ADJUSTABLE RATE
PREFERRED STOCKS............... 18,670,287
-----------
BANKING -- 30.7%
BankAmerica Corporation:
9,700 Series A, Adj. Rate Pfd....... 479,544
73,800 Series B, Adj. Rate Pfd....... 6,997,163
BankBoston Corporation:
13,400 Series A, Adj. Rate Pfd....... 618,913
114,900 Series B, Adj. Rate Pfd....... 5,328,488
42,773 Series C, Adj. Rate Pfd....... 3,635,705
322,100 Bankers Trust New York
Corporation,
Series Q, Adj. Rate Pfd....... 7,670,006
Chase Manhattan Corporation:
70,475 Series L, Adj. Rate Pfd....... 6,977,025
22,200 Series N, Adj. Rate Pfd....... 557,775
Citicorp:
89,100 Second Series, Adj. Rate
Pfd........................... 8,453,363
11,500 Third Series, Adj. Rate
Pfd........................... 1,147,125
80,600 Series 18, Adj. Rate Pfd...... 2,004,925
42,400 Series 19, Adj. Rate Pfd...... 1,057,350
<CAPTION>
VALUE
SHARES (NOTE 1)
- --------- -----------
<C> <S> <C>
PREFERRED STOCKS AND SECURITIES (CONTINUED)
ADJUSTABLE RATE PREFERRED STOCKS (CONTINUED)
BANKING (CONTINUED)
First Chicago NBD:
72,775 Series B, Adj. Rate Pfd....... $ 6,877,238
34,000 Series C, Adj. Rate Pfd....... 3,306,500
176,300 MBNA Corporation,
Series B, Adj. Rate Pfd....... 4,771,119
37,100 Morgan (J.P.) & Company Inc.,
Series A, Adj. Rate Pfd....... 2,949,450
91,750 Republic New York Corporation,
Series D, Adj. Rate Pfd....... 2,270,813
20,000 Wells Fargo & Company,
Series B, Adj. Rate Pfd....... 917,500
-----------
TOTAL BANKING ADJUSTABLE RATE
PREFERRED STOCKS............... 66,020,002
-----------
TOTAL ADJUSTABLE RATE PREFERRED
STOCKS......................... 84,690,289
-----------
FIXED RATE PREFERRED STOCKS AND SECURITIES -- 58.4%
UTILITIES -- 35.4%
Alabama Power Company:
75,000 7.375 % TOPRS................. 1,831,875
56,500 7.60% TOPRS................... 1,391,312
140,900 Class A, 6.40% Pfd............ 3,455,573
28,600 Series 1992-2, 7.60% Pfd...... 715,357
45,000 Appalachian Power Company,
Series A, 8.25% TOPRS......... 1,136,250
21,100 Arizona Public Service Company,
Series W, 7.25% Pfd........... 536,731
Baltimore Gas & Electric
Company:
21,250 Series 1993, 6.70% Pfd........ 2,210,000
44,750 Series 1995, 6.99% Pfd........ 4,816,219
8,793 Boston Edison Company,
4.78% Pfd..................... 601,221
5,000 Central Hudson Gas & Electric
Corporation,
Series D, 4.35% Pfd........... 313,750
18,000 Columbus Southern Power Company,
Series B, 7.92% Pfd........... 445,050
10,000 Consolidated Edison Company of
New York,
Series A, 7.75% QUIPS......... 248,750
Consumers Power Company:
128,747 Class A, 8.32% Pfd............ 3,363,515
2,850 Series G, $7.76 Pfd........... 286,069
</TABLE>
See Notes to Financial Statements.
7
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
MAY 31, 1997 (UNAUDITED)
- --------------------------------------------------
<TABLE>
<CAPTION>
VALUE
SHARES (NOTE 1)
- --------- -----------
PREFERRED STOCKS AND SECURITIES (CONTINUED)
<C> <S> <C>
FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
UTILITIES (CONTINUED)
60,000 CPL Capital,
Series A, 8.00% QUIPS......... $ 1,522,500
6,870 Dayton Power & Light Company,
Series C, 3.90% Pfd........... 410,483
25,300 Detroit Edison Company,
7.75% Pfd..................... 653,056
Duke Power Company:
17,900 Series C, 4.50% Pfd........... 1,268,663
6,000 Series R, 7.50% Pfd........... 629,250
8,600 Series S, 7.85% Pfd........... 937,400
8,400 Series W, 7.00% Pfd........... 896,700
53,500 Duquesne Capital,
Series A, 8.375% MIPS......... 1,350,875
71,750 El Paso, Tennessee Pipeline
Company,
Series A, 8.25% Pfd........... 3,928,312
Entergy Mississippi Inc.:
12,436 4.92% Pfd..................... 808,340
6,000 8.36% Pfd..................... 613,500
Florida Power & Light Company:
30,250 Series S, 6.98% Pfd........... 3,214,063
16,600 Series T, 7.05% Pfd........... 1,778,275
12,500 Georgia Power,
7.60% TOPRS................... 309,062
8,000 Gulf Power Company,
Series A, 7.625% QUIPS........ 198,200
10,000 Hawaiian Electric Industries,
8.36% TOPRS................... 252,500
Illinois Power Company:
4,530 Series A, 4.08% Pfd........... 132,503
8,960 Series D, 4.42% Pfd........... 283,360
29,370 Series E, 4.70% Pfd........... 987,566
10,000 Jersey Central Power & Light
Company,
Series K, 7.52% Sinking Fund
Pfd........................... 1,046,250
45,400 Mississippi Power Company,
7.25% Pfd..................... 1,154,863
8,500 Monongahela Power Company,
Series L, $7.73 Pfd........... 922,250
Montana Power Company:
5,600 $6.875 Pfd.................... 585,900
52,000 Series A, 8.45% QUIPS......... 1,332,500
New York State Electric & Gas
Corporation:
5,000 6.30% Sinking Fund Pfd........ 506,250
6,956 6.48% Pfd..................... 679,949
<CAPTION>
VALUE
SHARES (NOTE 1)
- --------- -----------
<C> <S> <C>
PREFERRED STOCKS AND SECURITIES (CONTINUED)
FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
UTILITIES (CONTINUED)
Niagara Mohawk Power
Corporation:
37,600 7.85% Sinking Fund Pfd........ $ 944,700
58,135 9.50% Pfd..................... 1,518,777
3,500 Northern Indiana Public Service
Company,
7.44% Pfd..................... 360,938
6,170 Ohio Edison Company,
4.44% Pfd..................... 342,435
7,500 Ohio Power Company,
Series B, 7.92% QUIDS......... 185,437
4,000 Pacificorp,
7.48% Sinking Fund Pfd........ 433,000
18,400 Pennsylvania Power Company,
7.75% Pfd..................... 1,736,500
PSI Energy, Inc.:
4,850 6.875% Pfd.................... 507,431
159,782 7.44% Pfd..................... 4,084,427
10,000 Public Service Company of New
Mexico,
4.58% PVT Pfd................. 485,000
Puget Sound Power & Light
Company:
13,650 7.75% Sinking Fund Pfd........ 1,440,075
23,568 7.875% Pfd.................... 593,619
115,900 Series II, 7.45% Pfd.......... 3,114,812
4,884 Rochester Gas & Electric
Corporation,
Series II, 4.10% Pfd.......... 283,883
54,200 San Diego Gas & Electric
Company,
6.80% Pfd..................... 1,419,362
43,000 Sierra Pacific Capital,
8.60% TOPRS................... 1,115,312
128,490 Swepco Capital,
Series A, 7.875% TOPRS........ 3,215,462
Transcanada Pipeline Ltd.:
113,900 8.50% COPRS................... 2,954,281
75,000 8.75% TOPRS................... 1,992,187
TU Capital:
29,050 Series M, 8.25% TOPRS......... 737,144
10,100 Series N, 9.00% TOPRS......... 262,600
5,200 Virginia Electric & Power
Company,
$6.98 Pfd..................... 551,850
-----------
TOTAL UTILITY FIXED RATE
PREFERRED STOCKS AND
SECURITIES..................... 76,033,474
-----------
</TABLE>
See Notes to Financial Statements.
8
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
MAY 31, 1997 (UNAUDITED)
--------------------------------------------------
<TABLE>
<CAPTION>
VALUE
SHARES (NOTE 1)
- --------- -----------
PREFERRED STOCKS AND SECURITIES (CONTINUED)
<C> <S> <C>
FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
BANKING -- 8.6%
3,600 ABN Amro North America,
6.59% Capital Security,
144A**........................ $ 3,609,000
Bankers Trust New York
Corporation,
2,000,000 Series B1, 7.90% Capital
Security, 144A**.............. 1,960,000
21,158 Series O, 7.625% Pfd.......... 543,496
2,250,000 Bank of New York,
7.78% Capital Security,
144A**........................ 2,185,594
Chase Manhattan Corporation:
142,089 Series C, 10.84% Pfd.......... 4,466,923
5,000 Series G, 10.96% Pfd.......... 153,750
Fleet Financial Group, Inc.:
20,000 Series E, 9.35% Pfd........... 561,250
38,100 Series G, 6.75% Pfd........... 2,038,350
2,000,000 First Union Institutional,
8.04% Capital Security,
144A**........................ 2,016,000
1,000,000 Summit Bancorp,
8.40% Capital Security,
144A**........................ 1,033,500
-----------
TOTAL BANKING FIXED RATE
PREFERRED STOCKS............... 18,567,863
-----------
FINANCIAL SERVICES -- 8.4%
133,300 Household International, Inc.,
8.70% TOPRS................... 3,532,450
109,498 Lehman Brothers Holdings Inc.,
5.00% Conv. Pfd............... 3,134,380
Merrill Lynch & Company, Inc.:
27,000 7.75% TOPRS................... 674,325
67,400 8.00% TOPRS................... 1,710,275
90,600 Series A, 9.00% Pfd........... 2,757,637
56,800 Morgan Stanley Group Inc.,
7.75% Pfd..................... 3,067,200
35 Prudential Management,
6.30% PVT Sinking Fund........ 3,115,000
-----------
TOTAL FINANCIAL SERVICES FIXED
RATE PREFERRED STOCKS AND
SECURITIES..................... 17,991,267
-----------
<CAPTION>
VALUE
SHARES (NOTE 1)
- --------- -----------
<C> <S> <C>
PREFERRED STOCKS AND SECURITIES (CONTINUED)
FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
INDUSTRIAL -- 3.8%
90,443 Coastal Corporation,
Series H, $2.125 Pfd.......... $ 2,311,949
111,800 Ford Motor Company,
Series B, 8.25% Pfd........... 3,109,438
87,633 James River Corporation,
Series O, 8.25% Pfd........... 2,229,164
9,520 Viad Corporation,
$4.75 Sinking Fund Pfd........ 556,920
-----------
TOTAL INDUSTRIAL FIXED RATE
PREFERRED STOCKS AND
SECURITIES..................... 8,207,471
-----------
INSURANCE -- 2.2%
116,000 AON Corporation,
8.00% Pfd..................... 2,965,250
70,681 Hartford Capital,
Series B, 8.35% QUIPS......... 1,820,036
-----------
TOTAL INSURANCE FIXED RATE
PREFERRED STOCKS AND
SECURITIES..................... 4,785,286
-----------
TOTAL FIXED RATE PREFERRED
STOCKS AND SECURITIES.......... 125,585,361
-----------
TOTAL PREFERRED STOCKS AND
SECURITIES (Cost
$197,867,793).................. 210,275,650
-----------
COMMON STOCKS -- 0.1% (Cost $289,250)
UTILITIES -- 0.1%
10,000 Consolidated Edison Company
of New York, Inc.............. 289,375
-----------
MISCELLANEOUS SECURITIES -- 0.5% (Cost $1,258,804)
Put Options on U.S. Treasury
Bond Futures.................. 939,084
-----------
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
MAY 31, 1997 (UNAUDITED)
- --------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL VALUE
AMOUNT (NOTE 1)
- --------- -----------
REPURCHASE AGREEMENT -- 1.4% (Cost $3,032,000)
<C> <S> <C>
$3,032,000 Agreement with UBS Securities
Inc., 5.50% dated 5/30/97, to
be repurchased at $3,033,390
on 6/2/97, collateralized by
$3,239,000 U.S. Treasury Note,
5.875% due 11/15/05 (value
$3,032,772)................... $ 3,032,000
-----------
</TABLE>
<TABLE>
<S> <C> <C>
TOTAL INVESTMENTS (Cost
$202,447,847*)..................... 98.8% 214,536,109
OTHER ASSETS AND LIABILITIES (NET)........ 0.2 527,501
--------- -------------
NET ASSETS................................ 100.0% $ 215,063,610
--------- -------------
--------- -------------
</TABLE>
- ----------------------------------
* Aggregate cost for Federal tax purposes.
** Security 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.
ABBREVIATIONS:
<TABLE>
<S> <C> <C>
COPRS -- Canadian Originated Preferred Securities (Note 7)
MIPS -- Monthly Income Preferred Securities (Note 7)
QUIDS -- Quarterly Income Debt Securities (Note 7)
QUIPS -- Quarterly Income Preferred Securities (Note 7)
TOPRS -- Trust Originated Preferred Securities (Note 7)
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
STATEMENT OF ASSETS AND LIABILITIES
MAY 31, 1997 (UNAUDITED)
--------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (Cost $202,447,847) (Note 1)
See accompanying schedule.................................. $ 214,536,109
Receivable for securities sold............................... 2,158,149
Dividends and interest receivable............................ 1,550,014
Prepaid expenses............................................. 79,264
-------------
Total Assets........................................... 218,323,536
LIABILITIES:
Payable for securities purchased............................. $ 2,688,495
Dividends payable............................................ 312,798
Investment advisory fee payable (Note 2)..................... 101,590
Accrued expenses and other payables.......................... 157,043
-----------
Total Liabilities...................................... 3,259,926
-------------
NET ASSETS....................................................... $ 215,063,610
-------------
-------------
NET ASSETS CONSIST OF:
Undistributed net investment income (Note 1)................. $ 192,180
Accumulated net realized gain on investments sold (Note 1)... 3,416,386
Unrealized appreciation of investments (Note 3).............. 12,088,262
Par value of Common Stock.................................... 98,386
Paid-in capital in excess of par value of Common Stock....... 141,768,396
Money Market Cumulative Preferred-TM- Stock (Note 5)......... 57,500,000
-------------
Total Net Assets....................................... $ 215,063,610
-------------
-------------
PER SHARE
-----------
NET ASSETS AVAILABLE TO:
Money Market Cumulative Preferred-TM- Stock (575 shares
outstanding) redemption value.............................. $100,000.00 $ 57,500,000
Accumulated undeclared dividends on Money Market
Cumulative Preferred-TM- Stock............................. 354.78 203,997
----------- -------------
$100,354.78 57,703,997
-----------
-----------
Common Stock (9,838,571 shares outstanding).................. $15.99 157,359,613
------ ------------
------
TOTAL NET ASSETS................................................. $ 215,063,610
-------------
-------------
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MAY 31, 1997 (UNAUDITED)
- --------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Dividends......................................................... $6,975,075
Interest.......................................................... 238,426
----------
Total Investment Income..................................... 7,213,501
EXPENSES:
Investment advisory fee (Note 2).................................. $ 593,783
Administration fee (Note 2)....................................... 127,488
Money Market Cumulative Preferred-TM- broker commissions
and Auction Agent fees.......................................... 72,678
Shareholder servicing agent fees (Note 2)......................... 51,535
Insurance expense................................................. 43,647
Legal and audit fees.............................................. 37,111
Directors' fees and expenses (Note 2)............................. 26,444
Economic consulting fee (Note 2).................................. 22,667
Custodian fees (Note 2)........................................... 18,980
Other............................................................. 31,533
---------
Total Expenses.............................................. 1,025,866
----------
NET INVESTMENT INCOME................................................. 6,187,635
----------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
(Notes 1 and 3):
Net realized gain on investments sold during the period........... 2,868,937
Change in net unrealized appreciation/(depreciation) of
investments
during the period............................................... (78,514)
----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS....................... 2,790,423
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS.................. $8,978,058
----------
----------
</TABLE>
See Notes to Financial Statements.
12
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
STATEMENT OF CHANGES IN NET ASSETS
----------------------------------------------
<TABLE>
<CAPTION>
SIX MONTHS ENDED
MAY 31, 1997 YEAR ENDED
(UNAUDITED) NOVEMBER 30, 1996
------------------ -------------------
<S> <C> <C>
OPERATIONS:
Net investment income................................................... $ 6,187,635 $ 13,470,109
Net realized gain on investments sold during the period................. 2,868,937 8,833,647
Change in net unrealized appreciation/(depreciation) of
investments during the period......................................... (78,514) (2,414,862)
------------------ -------------------
Net increase in net assets resulting from operations.................. 8,978,058 19,888,894
DISTRIBUTIONS:
Dividends paid from net investment income to Money Market
Cumulative Preferred-TM- Stock Shareholders (Note 5).................. (1,364,623) (1,477,504)
Distributions paid from net realized capital gains to Money Market
Cumulative Preferred-TM- Stock Shareholders (Note 5).................. (93,525) (760,850)
Dividends paid from net investment income to Common Stock
Shareholders.......................................................... (6,157,428) (10,615,834)
Distributions paid from net realized capital gains to Common Stock
Shareholders.......................................................... (6,386,813) --
------------------ -------------------
NET INCREASE/(DECREASE) IN NET ASSETS FOR THE PERIOD...................... (5,024,331) 7,034,706
NET ASSETS:
Beginning of period..................................................... 220,087,941 213,053,235
------------------ -------------------
End of period (including undistributed net investment
income of $192,180 and $1,526,596, respectively)...................... $ 215,063,610 $ 220,087,941
------------------ -------------------
------------------ -------------------
</TABLE>
See Notes to Financial Statements.
13
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD.
- --------------------------------------------------------
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.
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED YEAR ENDED YEAR ENDED
MAY 31, 1997 NOVEMBER 30, NOVEMBER 30, NOVEMBER 30,
(UNAUDITED) 1996 1995 1994
-------------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
OPERATING PERFORMANCE:
Net asset value, beginning of period....... $ 16.50 $ 15.80 $ 14.74 $ 18.39
----------- ---------------- ---------------- ----------------
Net investment income...................... 0.63 1.37 1.48 1.42
Net realized and unrealized gain/(loss) on
investments............................... 0.28 0.65 2.05 (2.06)
----------- ---------------- ---------------- ----------------
Net increase/(decrease)in net asset value
resulting from investment operations...... 0.91 2.02 3.53 (0.64)
Offering costs and MMP**** underwriting
commisions charged to paid-in capital..... -- -- -- --
DISTRIBUTIONS:
Dividends paid from net investment income
to MMP**** Shareholders................... (0.14) (0.15) (0.26) (0.16)
Distributions paid from net realized
capital gains to MMP**** Shareholders..... (0.01) (0.08) (0.01) (0.07)
Dividends paid from net investment income
to Common Stock Shareholders.............. (0.63) (1.08) (1.36) (1.15)
Distributions paid from net realized
capital gains to Common Stock
Shareholders.............................. (0.65) -- (0.83) (1.64)
Change in accumulated undeclared dividends
on MMP****................................ 0.01 (0.01) (0.01) 0.01
----------- ---------------- ---------------- ----------------
Total distributions........................ (1.42) (1.32) (2.47) (3.01)
----------- ---------------- ---------------- ----------------
Net asset value, end of period............. $ 15.99 $ 16.50 $ 15.80 $ 14.74
----------- ---------------- ---------------- ----------------
----------- ---------------- ---------------- ----------------
Market value, end of period................ $ 15.250 $ 15.500 $ 14.125 $ 13.500
----------- ---------------- ---------------- ----------------
----------- ---------------- ---------------- ----------------
Total investment return based on net asset
value***.................................. 5.26% 12.78% 25.13% (5.22)%
----------- ---------------- ---------------- ----------------
----------- ---------------- ---------------- ----------------
Total investment return based on market
value***.................................. 6.86% 18.50% 22.14% (13.12)%
----------- ---------------- ---------------- ----------------
----------- ---------------- ---------------- ----------------
Net assets, end of period (in 000's)....... $ 215,064 $ 220,088 $ 213,053 $ 199,386
----------- ---------------- ---------------- ----------------
----------- ---------------- ---------------- ----------------
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO
COMMON STOCK SHAREHOLDERS/SUPPLEMENTAL
DATA:
Net investment income.................... 6.17%** 7.22% 8.33% 7.55%
Operating expenses....................... 1.32%** 1.51% 1.55% 1.52%
Portfolio turnover rate.................. 31% 98% 94% 98%
EXPENSE RATIO TO TOTAL AVERAGE NET ASSETS
(WHICH INCLUDES MMP****):
Operating expenses....................... 0.96%** 1.10% 1.11% 1.11%
<CAPTION>
YEAR ENDED YEAR ENDED PERIOD ENDED
NOVEMBER 30, NOVEMBER 30, NOVEMBER 30,
1993 1992 1991*
---------------- ---------------- ----------------
<S> <C> <C> <C>
OPERATING PERFORMANCE:
Net asset value, beginning of period....... $ 18.59 $ 16.56 $ 13.95
---------------- ---------------- ----------------
Net investment income...................... 1.48 1.75 1.43
Net realized and unrealized gain/(loss) on
investments............................... 1.37 2.82 2.67
---------------- ---------------- ----------------
Net increase/(decrease)in net asset value
resulting from investment operations...... 2.85 4.57 4.10
Offering costs and MMP**** underwriting
commisions charged to paid-in capital..... -- -- (0.27)
DISTRIBUTIONS:
Dividends paid from net investment income
to MMP**** Shareholders................... (0.12) (0.17) (0.15)
Distributions paid from net realized
capital gains to MMP**** Shareholders..... (0.07) (0.09) (0.04)
Dividends paid from net investment income
to Common Stock Shareholders.............. (1.34) (1.72) (0.99)
Distributions paid from net realized
capital gains to Common Stock
Shareholders.............................. (1.51) (0.59) --
Change in accumulated undeclared dividends
on MMP****................................ (0.01) 0.03 (0.04)
---------------- ---------------- ----------------
Total distributions........................ (3.05) (2.54) (1.22)
---------------- ---------------- ----------------
Net asset value, end of period............. $ 18.39 $ 18.59 $ 16.56
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Market value, end of period................ $ 18.375 $ 19.625 $ 17.875
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Total investment return based on net asset
value***.................................. 15.54% 27.70% 26.16%
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Total investment return based on market
value***.................................. 9.33% 24.89% 26.68%
---------------- ---------------- ----------------
---------------- ---------------- ----------------
Net assets, end of period (in 000's)....... $ 225,896 $ 214,593 $ 187,928
---------------- ---------------- ----------------
---------------- ---------------- ----------------
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO
COMMON STOCK SHAREHOLDERS/SUPPLEMENTAL
DATA:
Net investment income.................... 7.33% 8.58% 9.18%**
Operating expenses....................... 1.50% 1.63% 1.67%**
Portfolio turnover rate.................. 110% 86% 90%
EXPENSE RATIO TO TOTAL AVERAGE NET ASSETS
(WHICH INCLUDES MMP****):
Operating expenses....................... 1.11% 1.17% 1.23%**
</TABLE>
- ----------------------------------------
* The Fund commenced operations on January 31, 1991.
** Annualized.
*** Assumes reinvestment of distributions.
**** Money Market Cumulative Preferred-TM- Stock
See Notes to Financial Statements.
14
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------
The table below sets out information with respect to Money Market Cumulative
Preferred-TM- Stock
currently outstanding.
<TABLE>
<CAPTION>
INVOLUNTARY AVERAGE
ASSET LIQUIDATING MARKET
TOTAL SHARES COVERAGE PREFERENCE VALUE
OUTSTANDING PER SHARE PER SHARE (1) PER SHARE (1) & (2)
--------------- ----------- ------------- -------------------
<S> <C> <C> <C> <C>
05/31/97 575 $ 374,024 $ 100,000 $ 100,000
11/30/96 575 382,762 100,000 100,000
11/30/95 575 370,527 100,000 100,000
11/30/94 575 346,759 100,000 100,000
11/30/93 575 392,862 100,000 100,000
11/30/92 575 373,205 100,000 100,000
11/30/91 575 326,832 100,000 100,000
</TABLE>
- ----------------------------------------
(1) Excludes accumulated undeclared dividends
(2) See Note 5.
See Notes to Financial Statements.
15
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
- ----------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
Preferred Income Fund Incorporated (the "Fund") is a diversified, closed-end
management investment company organized as a Maryland corporation on September
28, 1990 and is registered with the Securities and Exchange Commission ("SEC")
under the Investment Company Act of 1940, as amended. The Fund commenced
operations on January 31, 1991. The policies described below are followed
consistently by the Fund in the preparation of its financial statements in
conformity with generally accepted accounting principles.
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 by dividing the value of
the Fund's net assets attributable to common shares by the number of shares of
Common Stock outstanding. The value of the Fund's net assets attributable to
common shares is deemed to equal the value of the Fund's total assets less (i)
the Fund's liabilities, (ii) the aggregate liquidation value of the outstanding
Money Market Cumulative Preferred-TM- Stock and (iii) accumulated and unpaid
dividends on the outstanding Money Market Cumulative Preferred-TM- Stock.
Securities listed on a national securities exchange are valued on the basis of
the last sale on such exchange on the day of valuation. In the absence of sales
of listed securities and with respect to securities for which the most recent
sale prices are not deemed to represent fair market value and unlisted
securities (other than money market instruments), securities are valued at the
mean between the closing bid and asked prices when quoted prices for investments
are readily available. Investments for which market quotations are not readily
available 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 considered comparable in quality,
maturity and type. Investments in money market instruments, which mature in 60
days or less, are valued at amortized cost.
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 identified cost basis. Dividend income is recorded on
ex-dividend dates. Interest income is recorded on the accrual basis.
OPTION ACCOUNTING PRINCIPLES: Upon the purchase of a put option by the
Fund, the total purchase price paid is recorded as an investment. The market
valuation is determined as set forth in the second preceding paragraph. 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.
REPURCHASE AGREEMENTS: The Fund may engage in repurchase agreement
transactions. The Fund's Board of Directors reviews and approves periodically
the eligibility of the banks and dealers with which the Fund enters 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 and, in the event of counterparty default, the Fund has the right to
use
16
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
-----------------------------------------------------------------
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.
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS: The Fund expects to declare
dividends on a monthly basis to shareholders of Common Stock. The shareholders
of Money Market Cumulative Preferred-TM- Stock are entitled to receive
cumulative cash dividends as declared by the Fund's Board of Directors.
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 corporate tax rate. Any taxes paid by the Fund on such net realized
long-term gains may be used by the Fund's Common Stock Shareholders as a credit
against their own tax liabilities subject to the Fund qualifying as a regulated
investment company as described in the following paragraph.
FEDERAL INCOME TAXES: The Fund intends 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.
Income distributions and capital gain distributions are determined in
accordance with income tax regulations which may differ from generally accepted
accounting principles. These differences are primarily due to differing
treatments of income and gains on various investment securities held by the
Fund, timing differences and the differing characterization of distributions
made by the Fund.
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the financial
statements. Actual results could differ from those estimates.
2. INVESTMENT ADVISORY FEE, DIRECTORS' FEES, ECONOMIC CONSULTING FEE,
ADMINISTRATION FEE AND TRANSFER AGENT 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 net assets up to $100 million
and 0.50% of the value of the Fund's average monthly net assets in excess of
$100 million.
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 $100 for each telephone
meeting. In addition, the Fund will reimburse all Directors for travel and
out-of-pocket expenses incurred in connection with such meetings.
17
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
- -----------------------------------------------------------------
Primark Decision Economics Inc. ("Primark") serves as the Fund's Economic
Consultant. The Fund pays Primark an annual fee equal to $45,333 for services
provided.
First Data Investor Services Group, Inc. ("Investor Services Group"), a
wholly owned subsidiary of First Data Corporation, serves as the Fund's
Administrator and Transfer Agent. As Administrator, Investor Services Group
calculates the net asset value of the Fund's shares and generally assists in all
aspects of the Fund's administration and operation. As compensation for Investor
Services Group's services as Administrator, the Fund pays Investor Services
Group a monthly fee at an annual rate of 0.12% of the Fund's average monthly net
assets. Boston Safe Deposit and Trust Company ("Boston Safe"), a wholly owned
subsidiary of Mellon Bank Corporation, serves as the Fund's Custodian. As
compensation for Boston Safe's services as Custodian, the Fund pays Boston Safe
a monthly fee at an annual rate of 0.01% of the Fund's average monthly net
assets. Investor Services Group also serves as the Fund's Common Stock servicing
agent (transfer agent), dividend-paying agent and registrar, and as compensation
for Investor Services Group's services as transfer agent, the Fund pays Investor
Services Group a fee at an annual rate of 0.02% of the Fund's average monthly
net assets plus certain out-of-pocket expenses.
Chase Manhattan Bank ("Auction Agent") serves as the Fund's Money Market
Cumulative Preferred-TM- Stock transfer agent, registrar, dividend disbursing
agent and redemption agent.
3. PURCHASES AND SALES OF SECURITIES
Cost of purchases and proceeds from sales of securities for the six months
ended May 31, 1997, excluding short-term investments, aggregated $63,957,045 and
$74,588,659, respectively.
At May 31, 1997, aggregate gross unrealized appreciation for all securities
in which there is an excess of value over tax cost was $12,701,527 and aggregate
gross unrealized depreciation for all securities in which there is an excess of
tax cost over value was $613,265.
4. COMMON STOCK
At May 31, 1997, 240,000,000 shares of $0.01 par value Common Stock were
authorized. There were no Common Stock transactions for the six months ended May
31, 1997 and the year ended November 30, 1996.
5. MONEY MARKET CUMULATIVE PREFERRED-TM- STOCK
The Fund's Articles of Incorporation authorize the issuance of up to
10,000,000 shares of $0.01 par value preferred stock. On April 17, 1991, the
Fund received proceeds from the public offering of 575 shares of Money Market
Cumulative Preferred-TM- Stock of $57,500,000 before offering costs of $234,375
and underwriting discounts and commissions paid directly to Lehman Brothers Inc.
of $1,006,250. The Money Market Cumulative Preferred-TM- Stock is senior to the
Common Stock and results in the financial leveraging of the Common Stock. Such
leveraging tends to magnify both the risks and opportunities to Common Stock
Shareholders. Dividends on shares of Money Market Cumulative Preferred-TM- Stock
are cumulative.
18
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
-----------------------------------------------------------------
The Fund is required to meet certain asset coverage tests with respect to
the Money Market Cumulative Preferred-TM- Stock. If the Fund fails to meet these
requirements and does not correct such failure, the Fund may be required to
redeem, in part or in full, Money Market Cumulative Preferred-TM- Stock at a
redemption price of $100,000 per share plus an amount equal to the accumulated
and unpaid dividends on such shares in order to meet these requirements.
Additionally, failure to meet the foregoing asset requirements could restrict
the Fund's ability to pay dividends to Common Stock Shareholders and could lead
to sales of portfolio securities at inopportune times.
If the Fund allocates any net gains or income ineligible for the Dividends
Received Deduction to shares of the Money Market Cumulative Preferred-TM- Stock,
the Fund may be required to make additional distributions to Money Market
Cumulative Preferred-TM- Stock Shareholders or to pay a higher dividend rate in
amounts needed to provide a return, net of tax, equal to the return had such
originally paid distributions been eligible for the Dividends Received
Deduction.
An auction of the Money Market Cumulative Preferred-TM- Stock is generally
held every 49 days. Existing shareholders may submit an order to hold, bid or
sell such shares at par value on each auction date. Money Market Cumulative
Preferred-TM- Stock Shareholders may also trade shares in the secondary market
between auction dates.
At May 31, 1997, 575 shares of Money Market Cumulative Preferred-TM- Stock
were outstanding at the annual rate of 4.12%. The dividend rate, as set by the
auction process, is generally expected to vary with short-term interest rates.
These 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 Common Stock Shareholders. While the
Fund expects to structure the portfolio holdings and hedging transactions to
lessen such risks to Common Stock Shareholders, there can be no assurance that
such results will be attained.
6. ORGANIZATION COSTS
Costs incurred by the Fund in connection with its organization and initial
public offering of Common Stock and Money Market Cumulative Preferred-TM- Stock
were $75,000 and $20,000, respectively, and were amortized on a straight-line
basis over a five year period beginning January 31, 1991 (the date of the Fund's
commencement of investment operations) and April 17, 1991 (the date of the
issuance of the Fund's Money Market Cumulative Preferred-TM- Stock),
respectively. As of May 31, 1997, all such costs have been fully amortized.
7. PORTFOLIO INVESTMENTS, CONCENTRATION AND INVESTMENT QUALITY
The Fund invests primarily in adjustable and fixed rate preferred securities
and related hybrid securities. Under normal market conditions, the Fund invests
at least 25% of its assets in securities issued by utilities and at least 25% of
its assets in securities issued by companies in the banking industry. The Fund's
portfolio may therefore be subject to greater risk and market fluctuation than a
portfolio of securities representing a broader range of investment alternatives.
The risks could adversely affect the ability and inclination of companies in
19
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
- -----------------------------------------------------------------
these industries to declare and pay dividends or interest and the ability of
holders of securities of such companies to realize any value from the assets of
the issuer upon liquidation or bankruptcy. The Fund may invest up to 15% of its
assets at the time of purchase in securities rated below investment grade,
provided that no such investment may be rated below both "Ba" by Moody's
Investors Service, Inc. and "BB" by Standard & Poor's Rating Group or judged to
be comparable in quality at the time of purchase; however, any such securities
must be issued by an issuer having an outstanding class of senior debt rated
investment grade. On May 3, 1997, the Fund amended its investment policy to
permit the Fund to invest up to 15% of its assets in common stock. The Fund's
investment policy regarding debt securities was amended on July 21, 1995. The
amended policy allows the Fund to invest up to 35% of its assets collectively in
the following: Trust Originated Preferred Securities ("TOPRS"), Monthly Income
Preferred Shares ("MIPS"), Quarterly Income Debt Securities ("QUIDS"), Quarterly
Income Preferred Shares ("QUIPS"), Canadian Originated Preferred Securities
("COPRS"), and similarly-structured instruments commonly referred to as hybrid
or taxable preferreds, subject to the quality standards set forth above.
8. 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
fundamental investment policies, involving any or all of the following: lending
of portfolio securities, short sales of securities, futures contracts, options
on futures contracts, and options on securities. With the exception of
purchasing securities on a when-issued or delayed delivery basis or lending
portfolio securities, these transactions are used for hedging or other
appropriate risk-management purposes or, under certain other circumstances, to
increase income. As of May 31, 1997, the Fund owned put options on U.S. Treasury
bond futures contracts. 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.
20
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
QUARTERLY RESULTS OF INVESTMENT OPERATIONS (UNAUDITED)
----------------------------------------------------------------------
<TABLE>
<CAPTION>
AVAILABLE TO COMMON STOCK SHAREHOLDERS
----------------------------------------------------------------------------------
NET REALIZED AND NET INCREASE/(DECREASE)
INVESTMENT NET INVESTMENT UNREALIZED GAIN/(LOSS) IN NET ASSETS FROM
INCOME INCOME ON INVESTMENTS OPERATIONS
-------------------------- -------------------------- --------------------------- -------------------------
QUARTER PER PER PER PER
ENDED TOTAL SHARE* TOTAL SHARE* TOTAL SHARE* TOTAL SHARE*
- ---------- ------------- ----------- ------------- ----------- -------------- ----------- -------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
02/28/95 $ 4,037,295 $ 0.41 $ 2,650,172 $ 0.27 $ 4,919,585 $ 0.50 $ 7,569,757 $ 0.77
05/31/95 4,359,693 0.44 3,125,100 0.31 9,197,708 0.94 12,322,808 1.25
08/31/95 4,334,243 0.44 3,102,458 0.32 851,550 0.09 3,954,008 0.41
11/30/95 4,151,157 0.42 3,032,814 0.31 5,118,508 0.52 8,151,322 0.83
02/28/96 3,825,761 0.39 2,608,007 0.27 (4,650,657) (0.47) (2,042,650) (0.20)
05/31/96 4,011,439 0.41 2,859,221 0.29 2,737,954 0.27 5,597,175 0.56
08/31/96 4,109,920 0.41 3,388,047 0.34 (1,126,981) (0.11) 2,261,066 0.23
11/30/96 3,839,482 0.39 3,009,704 0.31 9,458,469 0.96 12,468,173 1.27
02/28/97 3,461,758 0.35 2,921,492 0.30 366,250 0.03 3,287,742 0.33
05/31/97 3,751,743 0.38 3,266,143 0.33 2,424,173 0.25 5,690,316 0.58
</TABLE>
- ------------------------
* Per share of common stock.
21
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Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED)
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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 own name will have all
distributions reinvested automatically by Investor Services Group 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, Investor Services Group will buy shares of the
Fund's Common Stock in the open market, on the New York Stock Exchange 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 Investor Services Group 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, Investor Services
Group 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 Investor
Services Group's open market purchases in connection with the reinvestment of
dividends or capital gains distributions. For the six months ended May 31, 1997,
$9,000 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.
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Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
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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.
A shareholder whose Common Stock is registered in his or her own name may
terminate participation in the Plan at any time by notifying Investor Services
Group in writing, by completing the form on the back of the Plan account
statement and forwarding it to Investor Services Group or by calling Investor
Services Group directly. A termination will be effective immediately if notice
is received by Investor Services Group 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, Investor Services Group 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 Investor Services Group at
1-800-331-1710.
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DIRECTORS
Martin Brody
Donald F. Crumrine, CFA
Robert T. Flaherty, CFA
David Gale
Morgan Gust
Robert F. Wulf, CFA
OFFICERS
Robert T. Flaherty, CFA
Chairman of the Board
and President
Donald F. Crumrine, CFA
Vice President
and Secretary
Robert M. Ettinger, CFA
Vice President
Peter C. Stimes, CFA
Vice President
and Treasurer
Carl D. Johns
Assistant Treasurer
INVESTMENT ADVISER
Flaherty & Crumrine Incorporated
e-mail: [email protected]
QUESTIONS CONCERNING YOUR SHARES OF 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 --
First Data Investor Services Group, Inc.
P.O. Box 1376
Boston, MA 02104
1-800-331-1710
THIS REPORT IS SENT TO SHAREHOLDERS OF PREFERRED
INCOME FUND INCORPORATED FOR THEIR INFORMATION.
IT IS NOT A PROSPECTUS, CIRCULAR OR REPRESENTATION
INTENDED FOR USE IN THE PURCHASE OR SALE OF
SHARES OF THE FUND OR OF ANY SECURITIES MENTIONED
IN THIS REPORT.
3201-SEM
[LOGO]
Semi-Annual
Report
May 31, 1997
