<PAGE>
PREFERRED INCOME FUND
INCORPORATED
Dear Shareholder:
The Preferred Income Fund's portfolio continues to produce good results.
The returns on net asset value were 5.8% in the first half of fiscal 1998 and
14.3% for the most recent 12 months. However, the numbers make it look easier
than it really was.
The success we have enjoyed in fiscal 1998 so far has been primarily due to
our active management of the Fund's preferred portfolio. Overall market
conditions were of little help at best, and in some ways they were downright
unfavorable. At times we felt a little like a salmon swimming up stream. Being
in the right place at the right time was critical.
All sectors of the Fund's portfolio of hedged preferreds produced good
returns and overcame what we spent for our hedges. The strongest contributor was
traditional preferreds eligible for the Dividends Received Deduction ("DRD")
available to corporate investors. However, adjustable rate preferreds ("ARPs")
and hybrid preferred securities also turned in good results. The best returns of
all were on our holdings of income oriented common stocks, which represent a
very small part of the Fund's portfolio.
The market for traditional preferreds eligible for the DRD has become an
interesting study in contrasts. As a result of the "creeping scarcity" of such
issues (which we have discussed many times before in these letters), many
traditional preferreds have reached prices that offer only "ho hum" investment
value. At the same time, the small number of new issues of traditional
preferreds coming to market has included several extraordinarily attractive
special situations. Are we buyers or sellers of traditional preferreds? The
answer is "Both!", but probably more of the latter.
In the first half of this year, we continued the steady reduction in the
Fund's position in ARPs that began over a year ago. These holdings are also
eligible for the DRD and have benefited from the creeping scarcity phenomenon.
Many of the ARPs that we disposed of were either retired by their issuers at
attractive prices or sold by us at prices that anticipated such retirements.
This has been a very successful reversal of the substantial increase in the
Fund's holdings of ARPs accomplished in 1995 and 1996 when they seemed
particularly cheap.
Our experience with hybrid preferreds is proof of the old adage that "All's
well that ends well." The hybrid market performed rather poorly in the first
half of this year, causing problems for investors who were slow to react. In
contrast, the Fund traded very actively in this sector of the preferred market
and earned a good return on hybrids while the market adjustment was taking
place. The end result: We now own significantly more hybrid preferreds, which
seem quite attractively valued at their current prices. The Question and Answer
Section that follows goes into this in greater detail.
As you can see from the pie charts, there has been a significant shift in
the Fund's portfolio over the last year from traditional fixed rate and
adjustable rate preferreds into hybrid preferreds. It would be nice
<PAGE>
to say that this was the product of a "grand plan." More realistically, it is
just the cumulative result of our efforts each day to buy whatever is cheap and
sell whatever is not. This is how we think money should be managed, and it seems
to work.
[PIE CHARTS]
5/31/97 5/31/98
------- -------
Preferred Income Fund
26.5%
39.4% 1.5%
2.1% 2.3%
.1%
37.6%
17.1%
41.3% 32.1%
--------------------------------------
---- Adjustable Rates
---- Traditional Fixed Rates
---- Non-DRD Preferreds & Securities
(Hybrids)
---- Common Stock
---- Cash & Other
--------------------------------------
While all of the foregoing activity was going on in the trenches of our
preferred portfolio, interest rates were wandering almost aimlessly. A small
decline in interest rates in May represented the only net change for the fiscal
first-half. In this kind of environment, our hedging is analogous to buying
insurance and never making a claim. Nonetheless, we will continue to hedge until
we discover a crystal ball that will tell us in advance when interest rate
trends are going to be this boring.
We are also pleased to report that the shareholders approved at the Fund's
Annual Meeting the "supermajority" requirement proposed by management. This
provision will make it more difficult to change certain key aspects of the Fund
without widespread support from the directors and the shareholders. These
features include the income objective of the Fund, its diversified status, and
the prohibition against the Fund attempting to "take over" other companies.
I urge you to read the following Question and Answer Section, which
contains additional information about your Fund.
Sincerely yours,
/s/ Robert T. Flaherty
Robert T. Flaherty
Chairman of the Board
June 8, 1998
2
<PAGE>
QUESTIONS AND ANSWERS
WHAT IS THE DIFFERENCE BETWEEN TRADITIONAL PREFERREDS AND HYBRID PREFERREDS?
It is all basically a matter of taxes. In other respects, the two are
really very similar.
Traditional preferreds are treated for tax purposes just like any other
equity security such as common stock. The issuer receives no deduction for tax
purposes for the dividend payments made to the holders of the preferred. On the
other hand, those dividends are 70% tax free to corporate investors due to the
Dividends Received Deduction ("DRD"). The purpose of the DRD is to eliminate in
part the double taxation of these dollars at the corporate level that would
otherwise occur.
Hybrid preferreds were created about 5 years ago for the purpose of
allowing issuers to get a deduction for the dividend payments on preferreds,
just like they deduct interest payments on debt securities. Since no tax is paid
by the issuer, there is no double tax to avoid and no DRD available to a
corporate holder of hybrids. Initially, hybrids were primarily purchased by
individual investors, but the market has now broadened to include institutions
as well.
WHY HAS THE EMERGENCE OF HYBRIDS CREATED A "CREEPING SCARCITY"
OF TRADITIONAL PREFERREDS?
Since the issuer gets a tax deduction, it can afford to pay investors
higher rates on hybrid preferreds and still be better off after taxes than if it
issued traditional preferreds. At the beginning, the market did not "charge"
enough more for hybrids to offset this tax advantage, so issuers concentrated
new financing in hybrids, both for raising new capital and for refinancing
outstanding issues of traditional preferreds. The following graph highlights
rather dramatically the rapid growth in hybrid securities outstanding compared
to the sluggish growth and, ultimately, the shrinkage of traditional preferreds.
3
<PAGE>
<TABLE>
<CAPTION>
Measurement Period HYBRID NET
(Fiscal Year Covered) DRD NET ISSUANCE ISSUANCE
<S> <C> <C>
1991 3.55 0.00
1992 7.17 0.00
1993 3.67 0.55
1994 0.84 3.39
1995 -6.70 10.71
1996 0.04 30.79
1997 -7.07 22.84
1998 -1.74 13.81
</TABLE>
WILL THE CREEPING SCARCITY GO ON INDEFINITELY?
The market has gotten smarter with the passage of time. Corporate investors
interested in the DRD have forced down the yields on the remaining supply of
traditional preferreds (by pushing their prices up). Simultaneously, as more
companies have issued hybrid preferreds, the market has demanded higher yields
for investors to soak up the supply. As a result, the markets have now come into
a balance that reasonably reflects the differences in tax treatment. We believe
we are close to the point where the two types of preferreds can co-exist
"peacefully".
The IRS has recently thrown a wild card into this game. It has audited one
of the original issuers of hybrids and has challenged in court the favorable tax
treatment received by the issuer. The IRS says it cannot see any real difference
between hybrid preferreds and equity financing such as traditional preferreds
and that the two should be treated the same. There is, of course, no way of
knowing now how this dispute might be resolved. A better bet is that Wall Street
will find a way around whatever comes out of this case and that hybrid
preferreds or similar securities are here to stay.
4
<PAGE>
HOW DID THE FUND DO SO WELL IN SUCH A TOUGH MARKET FOR HYBRIDS?
The hybrid preferred market suffered from a "one-two punch" in the fiscal
first half. First, the financial problems in Asia impacted hybrids along with
the corporate bond market generally. Second, a steady stream of 44 new issues of
hybrids put additional supply pressure on the market. Relative to the Treasury
bond market (which is the basis of our hedges), all 44 new hybrid issues were
cheaper on May 31st than when they were initially offered to the public.
Selectivity is key in a market like this. We participated, at one time or
another, in only 13 of the 44 new hybrid issues and purchased only two in their
initial public offerings. Most of our purchases were designed to take advantage
of temporary market mispricings that we identified. It was essential to move
elsewhere after those opportunities were captured, and we did. Individually,
none of these moves was a "big deal"; but collectively, they added up to
something very worthwhile.
HOW WILL THE GROWTH OF HYBRIDS AFFECT THE PORTION OF THE FUND'S DIVIDENDS
QUALIFYING FOR THE DRD?
The percentage of the Fund's dividends eligible for the DRD will probably
decline as time goes by. This seems like an inevitable result as hybrids account
for an ever larger proportion of the overall preferred market. As of May 31,
1998, however, traditional preferreds that qualify for the DRD still accounted
for almost two-thirds of the Fund's portfolio.
The good news is that increasing the Fund's holdings of hybrids typically
has a positive effect on our income. We expect that, over a period of time, this
will provide a meaningful offset to the reduced availability of the DRD to our
shareholders that are subject to corporate income taxes.
5
<PAGE>
IS THERE ANYTHING NEW ON THE DISCOUNT OF THE MARKET PRICE OF THE FUND SHARES
FROM NET ASSET VALUE?
The following graph tells the story. The discount from net asset value
continues to fluctuate in a rather narrow range. This allows the market price of
the Fund's shares to reflect the positive performance of their underlying NAV.
[GRAPH]
PFK
GRAPHS
PREMIUM/
DATE DISCOUNT
---- --------
02/08/91 8.42
02/15/91 4.38
02/22/91 3.95
03/01/91 4.24
03/08/91 1.83
03/15/91 1.51
03/22/91 2.01
03/29/91 2.30
04/05/91 1.49
04/12/91 1.96
04/19/91 3.14
04/26/91 2.68
05/03/91 2.30
05/10/91 1.20
05/17/91 1.46
05/24/91 1.39
05/31/91 5.10
06/07/91 4.23
06/14/91 3.37
06/21/91 6.16
06/28/91 6.59
07/05/91 7.26
07/12/91 6.59
07/19/91 6.43
07/26191 5.49
08/02/91 6.78
08/09/91 4.15
08/16/91 3.72
08/23/91 5.71
08/30/91 3.14
09/06/91 5.70
09/13/91 8.83
09/20/91 5.75
09/27/91 6.06
10/04/91 7.64
10/11/91 7.45
10/18/91 7.19
10/25/91 5.87
11/01/91 6.93
11/08191 8.27
11/15/91 8.01
11/22/91 6.50
11/29/91 8.07
12/06/91 6.41
12/13/91 7.91
12/20/91 8.39
12/27/91 10.57
01/03/92 11.68
01/10/92 12.67
01117/92 9.78
01/24/92 9.12
01/31/92 4.17
02/07/92 4.04
02/14/92 6.13
02/21/92 4.90
02/28/92 3.81
03/06/92 3.39
03/13/92 3.75
03/20/92 3.87
03/27/92 3.27
04/03/92 3.57
04110/92 3.81
04/17/92 4.64
04/24/92 4.93
05/01/92 5.23
05108/92 3.12
05/15/92 3.47
05/22/92 0.83
05129/92 0.39
06/05/92 2.34
06112/92 3.08
06/19/92 2.27
06/26/92 4.91
07/03/92 4.91
07/10/92 5.25
07/17/92 5.70
07/24/92 7.12
07/31/92 5.80
08/07/92 5.34
08/14/92 3.89
08/21/92 3.06
08/28/92 2.50
09/04/92 2.28
09/11/92 3.56
09/18/92 4.89
09/25/92 4.06
10/02/92 7.16
10/09/92 4.83
10/16/92 4.17
10/23/92 3.78
10/30/92 8.40
11/06/92 3.78
11/13/92 5.90
11/20/92 5.51
11/27/92 5.74
12/04/92 6.80
12/11/92 6.01
12/18/92 5.82
12/25/92 6.18
01/01/93 7.39
01/08/93 9.87
01/15/93 11.45
01/22/93 10.21
01/29/93 7.60
02/05/93 6.02
02/12/93 4.52
02/19/93 4.34
02/26/93 6.28
03/05/93 9.09
03/12/93 6.07
03/19/93 2.48
03/26/93 6.38
04/02/93 8.76
04/09/93 7.64
04/16/93 6.71
04/23/93 7.64
04/30/93 6.77
05/07/93 9.18
05/14/93 7.79
05/21/93 7.00
05/28/93 7.40
06/04/93 4.97
06/11/93 5.26
06/18/93 5.60
06/25/93 7.03
07/02/93 4.51
07/09/93 5.41
07/16/93 4.90
07/23/93 5.76
07/30/93 5.98
08/06/93 7.90
08/13/93 4.84
08/02/93 3.77
08/27/93 4.34
09/03/93 4.50
09/10/93 3.61
09/17/93 4.00
09/24/93 3.21
10/01/93 2.93
10/08/93 1.10
10/15/93 1.73
10/22/93 0.48
10/29/93 -0.75
11/05/93 0.95
11/12/93 0.19
11/19/93 -3.16
11/26/93 0.30
12/03/93 -1.75
12/10/93 -1.03
12/17/93 3.23
12/24/93 -0.51
12/31/93 -2.87
01/07/94 0.93
01/14/94 0.75
01/21/94 -2.00
01/28/94 -3.16
02/04/94 -1.96
02/11/94 -2.24
02/18/94 -7.41
02/25/94 -5.39
03/04/94 -0.89
03/11/94 -2.70
03/18/94 -3.79
03/25/94 -5.05
04/01/94 -4.66
04/08/94 -7.13
04/15/94 -5.96
04/22/94 -5.98
04/29/94 -8.63
05/06/94 -5.81
05/13/94 -6.35
05/20/94 -4.09
05/27/94 -3.97
06/03/94 -2.86
06/10/94 1.46
06/17/94 -0.37
06/24/94 1.75
07/01/94 0.06
07/08/94 0.63
07/15/94 1.88
07/22294 -0.84
07/29/94 -0.79
08/05/94 -1.57
08/12/94 -2.15
08/19/94 -2.63
08/26/94 -4.39
09/02/94 -3.79
09/09/94 -2.32
09/16/94 -2.93
09/23/94 -2.73
09/30/94 -5.65
10/07/94 -11.41
10/14/94 -12.51
10/21/94 -14.16
10/28/94 -7.32
11/04/94 -9.48
11/11/94 -9.12
11/18/94 -9.51
11/23/94 -7.03
12/02/94 -5.93
12/09/94 -5.08
12/16/94 -5.54
12/23/94 -8.22
12/30/94 -7.44
01/06/95 -1.10
01/13/95 -1.34
01/20/95 -5.25
01/27/95 -6.97
02/03/95 0.61
02/10/95 -2.89
02/17/95 -4.19
02/24/95 -0.92
03/03/95 0.35
03110/95 -3.58
03/17/95 -5.79
03/24/95 -5.68
03/31/95 -2.90
04/07/95 -2.56
04/14/95 -3.04
04/21/95 -4.39
04/28/95 -2.71
05/05/95 -3.98
05/12/95 -2.62
05/19/95 -4.10
05/26/95 -8.70
06/02/95 -2.59
06/09/95 -6.08
06/16/95 -7.59
06/23/95 -8.84
06/30/95 -7.53
07/07/95 -8.44
07/14/95 -9.14
07/21/95 -9.76
07/28/95 -9.17
08/04/95 -8.88
08/11/95 -9.35
08/18/95 -9.42
08/25/95 -8.32
09/01/95 -6.98
09/08/95 -8.16
09/15/95 -9.68
09/22/95 -9.78
09/29/95 -8.97
10/06/95 -8.93
10/13/95 -10.94
10/20/95 -10.48
10/27/95 -12.10
11/03/95 -11.51
11/10/95 -11.46
11/17/95 -11.17
11/24/95 -10.43
12/01/95 -10.71
12/08/95 -11.92
12/15/95 -12.44
12/22/95 -12.56
12/29/95 -13.13
01/05/96 -13.65
01/12/96 -14.35
01/19/96 -14.59
01/26/96 -12.51
02/02/96 -12.44
02/09/96 -12.38
02/16/96 -13.60
02/23/96 -12.81
03/01/96 -11.18
03/08/96 -10.89
03/15/96 -15.21
03/22/96 -15.64
03/29/96 -14.64
04/05/96 -13.43
04/12/96 -14.77
04/19/96 -14.02
04/26/96 -14.88
05/03/96 -14.77
05/10/96 -15.32
05/17/96 -13.63
05/24/96 -14.32
05/31/96 -11.11
06/07/96 -11.80
06/14/96 -10.83
06/21/96 -11,29
06/28/96 -10.49
07/05/96 -10.31
07/12/96 -10.60
07/19/96 -10.71
07/26/96 -10.77
08/02/96 -10.26
08/09/96 -5.74
08/16/96 -7.14
08/23/96 -7.05
08/30/96 -6.69
09/06/96 -8.24
09/13/96 -7.56
09/20/96 -11.06
09/27/96 -11.06
10/04/96 -8.61
10/11/96 -9.41
10/18/96 -9.98
10/25/96 -8.58
11/01/96 -7.01
11/08/96 -8.31
11/15/96 -8.33
11/22/96 -6.53
11/29/96 -6.06
12/06/96 -6.67
12/13/96 -8.31
12/20/96 -7.49
12/27/96 -7.50
01/03/97 -2.42
01/10/97 -2.91
01/17/97 -4.65
01/24/97 -4.10
01/31/97 -4.59
02/07/97 -6.75
02/14/97 -4.64
02/21/97 -5.39
02/28/97 -5.50
03/07/97 -5.84
03/14/97 -6.37
03/21/97 -7.52
03/28/97 -6.62
04/04/97 -5.48
04/11/97 -8.81
04/18/97 -9.76
04/25/97 -8.52
05/02/97 -4.51
05/09/97 -5.78
05/16/97 -6.07
05/23/97 -5.54
05/30/97 -4.63
06/06/97 -5.10
06/13/97 -4.86
06/20/97 -2.54
06/27/97 -4.29
07/04/97 -3.85
07/11/97 -5.37
07/18/97 -5.83
07/25/97 -5.19
08/01/97 -4.98
08/08/97 -5.83
08/15/97 -7.84
08/22/97 -7.39
08/29/97 -4.69
09/05/97 -5.95
09/12/97 -6.23
09/19/97 -6.51
09/26/97 -6.04
10/03/97 -2.24
10/10/97 -3.85
10/17/97 -5.14
10/24/97 -4.83
10/31/97 -5.17
11/07/97 -4.25
11/14/97 -5.54
11/21/97 -6.70
11/28/97 -6.12
12/05/97 -4.31
12/12/97 -4.45
12/19/97 -6.32
12/26/97 -6.21
01/02/98 -0.90
01/09/98 -2.11
01/16/98 -0.12
01/23/98 -4.31
01/30/98 -3.58
02/06/98 -3.64
02/13/98 -4.74
02/20/98 -4.66
02/27/98 -4.46
03/06/98 -4.80
03/13/98 -5.95
03/20/98 -4.37
03/27/98 -5.18
04/03/98 -6.45
04/10/98 -5.09
04/17/98 -5.80
04/24/98 -6.63
05/01/98 -4.22
05/08/98 -5.89
05/15/98 -6.81
05/22/98 -5.52
05/29/98 -4.96
6
<PAGE>
- --------------------------------------------------------------------------------
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 $14.7500 $15.23
January 31, 1997.................................... 0.087 15.46 14.7500 14.73
February 28, 1997................................... 0.087 15.74 14.7500 14.88
March 31, 1997...................................... 0.087 15.95 15.1250 15.16
April 30, 1997...................................... 0.087 15.84 14.8750 14.94
May 31, 1997........................................ 0.087 15.99 15.2500 15.27
June 30, 1997....................................... 0.087 16.12 15.5625 15.59
July 31, 1997....................................... 0.087 16.55 15.9375 16.03
August 31, 1997..................................... 0.087 16.46 15.6875 15.86
September 30, 1997.................................. 0.087 16.64 15.8750 16.12
October 31, 1997.................................... 0.087 16.74 15.8750 15.98
November 30, 1997................................... 0.087 16.71 16.1875 15.92
December 31, 1997................................... 0.460 16.43 16.1250 16.40
January 31, 1998.................................... 0.081 16.53 15.9375 15.98
February 28, 1998................................... 0.081 16.55 15.8125 15.80
March 31, 1998...................................... 0.081 16.63 15.8125 15.82
April 30, 1998...................................... 0.081 16.64 15.6250 15.68
May 31, 1998........................................ 0.081 16.77 15.9375 15.98
</TABLE>
- ---------------
(1) See ADDITIONAL INFORMATION; Dividend Reinvestment and Cash Purchase Plan on
pages 23 and 24 of this report.
7
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS
MAY 31, 1998 (UNAUDITED)
- --------------------------------------------
<TABLE>
<CAPTION>
VALUE
SHARES/PAR (NOTE 1)
- ---------- --------
<C> <S> <C>
PREFERRED STOCKS AND SECURITIES -- 96.2 %
ADJUSTABLE RATE PREFERRED STOCKS -- 26.5 %
UTILITIES -- 6.3 %
24,920 Arizona Public Service Company,
Series Q, Adj. Rate Pfd. ...... $ 2,482,641
194,960 New York State Electric & Gas
Corporation,
Series B, Adj. Rate Pfd. ...... 4,703,410
Niagara Mohawk Power Corporation:
154,879 Series A, Adj. Rate Pfd. ........ 3,823,575
32,455 Series B, Adj. Rate Pfd. ........ 824,560
88,745 Series C, Adj. Rate Pfd. ........ 2,249,131
------------
TOTAL UTILITY ADJUSTABLE RATE
PREFERRED STOCKS............... 14,083,317
------------
BANKING -- 20.2 %
BankAmerica Corporation:
9,700 Series A, Adj. Rate Pfd. ........ 485,606
12,300 Series B, Adj. Rate Pfd. ........ 1,231,538
BankBoston Corporation:
13,400 Series A, Adj. Rate Pfd. ........ 670,000
119,900 Series B, Adj. Rate Pfd. ........ 5,995,000
48,073 Series C, Adj. Rate Pfd. ........ 4,795,282
Bankers Trust New York
Corporation:
262,100 Series Q, Adj. Rate Pfd. ...... 6,503,356
68,200 Series R, Adj. Rate Pfd. ........ 1,692,213
Chase Manhattan Corporation:
72,275 Series L, Adj. Rate Pfd. ........ 7,222,983
10,000 Series N, Adj. Rate Pfd. ........ 250,000
Citicorp:
80,600 Series 18, Adj. Rate Pfd. ....... 2,004,925
42,400 Series 19, Adj. Rate Pfd. ....... 1,054,700
First Chicago NBD:
30,175 Series B, Adj. Rate Pfd. ........ 3,025,044
34,000 Series C, Adj. Rate Pfd. ........ 3,419,125
54,100 Morgan (J.P.) & Company Inc.,
Series A, Adj. Rate Pfd. ...... 5,166,550
12,200 Republic New York Corporation,
Series D, Adj. Rate Pfd. ...... 305,763
20,000 Wells Fargo & Company, Series B,
Adj. Rate Pfd. ................ 982,500
------------
TOTAL BANKING ADJUSTABLE RATE
PREFERRED STOCKS............... 44,804,585
------------
</TABLE>
<TABLE>
<CAPTION>
VALUE
SHARES/PAR (NOTE 1)
- ---------- --------
<C> <S> <C>
TOTAL ADJUSTABLE RATE
PREFERRED STOCKS............... $ 58,887,902
------------
FIXED RATE PREFERRED STOCKS AND SECURITIES -- 69.7 %
UTILITIES -- 30.5 %
Alabama Power Company:
86,500 Class A, 6.40% Pfd. ............. 2,211,156
12,000 Series A, 7.125%, Sr. Notes...... 295,950
75,000 7.375% TOPRS..................... 1,898,438
80,000 7.60% TOPRS...................... 2,055,000
25,500 Appalachian Power Company,
Series A, 8.25% TOPRS.......... 664,594
21,100 Arizona Public Service Company,
Series W, 7.25% Pfd. .......... 536,731
Baltimore Gas & Electric Company:
4,750 Series 1993, 6.70% Pfd. ......... 539,125
44,750 Series 1995, 6.99% Pfd. ......... 5,263,719
10,000 Boston Edison Company, 4.78%
Pfd. .......................... 872,500
5,000 Central Hudson Gas & Electric
Corporation,
Series D, 4.35% Pfd. .......... 395,625
18,000 Columbus Southern Power Company,
Series B, 7.92% Jr. Sub.
Debt........................... 455,625
33,800 Consolidated Edison Company
of New York, Series A, 7.75%
QUICS.......................... 868,238
80,850 CPL Capital, Series A, 8.00%
QUIPS.......................... 2,076,834
6,870 Dayton Power & Light Company,
Series C, 3.90% Pfd. .......... 500,651
Duke Power Company:
5,550 Series C, 4.50% Pfd. ............ 477,994
3,412 Series S, 7.85% Pfd. ............ 397,072
565 Series W, 7.00% Pfd. ............ 63,774
54,000 Duquesne Capital, Series A,
8.375% MIPS.................... 1,393,875
26,000 Duquesne Light, 7.375% QUIBS..... 649,025
10,900 El Paso, Tennessee Pipeline
Company,
Series A, 8.25% Pfd. .......... 618,575
</TABLE>
See Notes to Financial Statements.
8
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
MAY 31, 1998 (UNAUDITED)
---------------------------------------------------------------
<TABLE>
<CAPTION>
VALUE
SHARES/PAR (NOTE 1)
- ---------- --------
<C> <S> <C>
PREFERRED STOCKS AND SECURITIES (CONTINUED)
FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
UTILITIES (CONTINUED)
Florida Power & Light Company:
30,250 Series S, 6.98% Pfd. ............ $ 3,403,125
16,600 Series T, 7.05% Pfd. ............ 1,884,100
14,000 Georgia Power, 7.75% TOPRS....... 361,375
8,000 Gulf Power Company, Series A,
7.625% QUIPS................... 204,500
Hawaiian Electric Industries:
20,000 8.05% QUIPS...................... 511,250
22,100 8.36% TOPRS...................... 575,981
Illinois Power Company:
4,530 Series A, 4.08% Pfd. ............ 171,008
8,960 Series D, 4.42% Pfd. ............ 359,520
29,370 Series E, 4.70% Pfd. ............ 1,251,896
14,250 Indianapolis Power & Light, 5.65%
Pfd. .......................... 1,494,469
10,000 Jersey Central Power & Light
Company,
Series K, 7.52% Sinking Fund
Pfd. .......................... 1,045,625
18,500 Long Island Lighting,
7.95% Sinking Fund Pfd. ....... 486,781
8,500 Monongahela Power Company,
Series L, $7.73 Pfd. .......... 996,625
23,500 Monongahela Power,
Series A, 8.00% QUIDS.......... 612,469
5,600 Montana Power Company,
$6.875 Pfd. ................... 635,600
10,000 MP&L Capital,
8.05% QUIPS.................... 256,875
New York State Electric & Gas
Corporation:
5,000 6.30% Sinking Fund Pfd. ......... 522,188
6,956 6.48% Pfd. ...................... 720,816
Niagara Mohawk Power Corporation:
30,111 7.85% Sinking Fund Pfd. ......... 769,712
58,135 9.50% Pfd. ...................... 1,544,211
3,500 Northern Indiana Public Service
Company, 7.44% Pfd. ........... 360,938
29,000 NSP Financing,
7.875% TOPRS................... 748,563
27,860 NVP Capital, Series A, 8.20%
QUIPS.......................... 715,654
</TABLE>
<TABLE>
<CAPTION>
VALUE
SHARES/PAR (NOTE 1)
- ---------- --------
<C> <S> <C>
6,170 Ohio Edison Company,
4.40% Pfd. .................... $ 443,469
Ohio Power Company:
33,600 Series A, 8.16% QUIDS............ 871,500
15,500 Series B, 7.92% QUIDS............ 392,344
55,300 7.375% Sr. Notes................. 1,380,426
PP&L Capital Trust:
104,700 8.10% TOPRS...................... 2,715,656
22,630 8.20% TOPRS...................... 586,966
48,000 PSCO Capital Trust,
7.60% TOPRS.................... 1,203,000
12,350 PSI Energy, Inc.,
6.875% Pfd. ................... 1,392,463
10,000 Public Service Company of New
Mexico,
4.58% Private Pfd. ............ 631,250
1,950,000 Puget Sound Capital Trust,
Series B, 8.231%
6/1/27 Capital Security........ 2,123,063
Puget Sound Power & Light
Company:
12,988 7.75% Sinking Fund Pfd. ......... 1,379,975
100,200 Series II, 7.45% Pfd. ........... 2,880,750
4,884 Rochester Gas & Electric
Corporation,
Series II, 4.10% Pfd. ......... 358,364
54,200 San Diego Gas & Electric Company,
6.80% Pfd. .................... 1,548,088
43,000 Sierra Pacific Capital,
8.60% TOPRS.................... 1,131,438
49,000 South Carolina Electric & Gas,
7.55% TOPRS.................... 1,246,438
35,000 Southwestern Public Service
Company,
7.85% TOPRS.................... 894,688
37,000 Transcanada Pipeline Ltd.,
8.75% COPRS.................... 978,188
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
MAY 31, 1998 (UNAUDITED)
- ---------------------------------------------------------------
<TABLE>
<CAPTION>
VALUE
SHARES/PAR (NOTE 1)
- ---------- --------
<C> <S> <C>
PREFERRED STOCKS AND SECURITIES (CONTINUED)
FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
UTILITIES (CONTINUED)
3,000,000 Union Electric Power Company,
7.69% 12/15/36 Capital
Security....................... $ 3,138,750
5,200 Virginia Electric & Power
Company,
$6.98 Pfd. .................... 585,650
------------
TOTAL UTILITY FIXED RATE
PREFERRED STOCKS AND
SECURITIES..................... 67,750,248
------------
BANKING -- 12.3 %
2,250 ABN Amro North America,
6.59% Pfd. 144A** ............. 2,491,875
21,158 Bankers Trust New York
Corporation,
Series O, 7.625% Pfd. ......... 528,950
1,000,000 BankBoston Capital Trust,
Series B, 7.75% 12/15/26
Capital Security............... 1,048,750
900,000 Bank of New York,
7.78% 12/1/26 Capital Security
144A** ........................ 951,750
1,750,000 BNY Capital,
Series B, 7.97% 12/31/26
Capital Security............... 1,890,000
1,500,000 BT Preferred Capital Trust,
7.875% 02/25/27 Capital
Security....................... 1,554,375
2,800,000 Chase Capital,
7.67% Capital Security......... 2,936,500
Chase Manhattan Corporation:
142,089 Series C, 10.84% Pfd. ........... 4,395,878
5,000 Series G, 10.96% Pfd. ........... 147,344
1,000,000 CitiCorp Capital,
8.015% 2/15/27 Capital
Security....................... 1,086,250
1,500,000 First Hawaiian Capital,
Series B, 8.343% 7/1/27 Capital
Security....................... 1,633,125
Fleet Financial Group, Inc.:
20,000 Series E, 9.35% Pfd. ............ 553,125
38,100 Series G, 6.75% Pfd. ............ 2,166,938
700,000 Great Western Financial
Corporation,
8.206% 2/1/27 Capital
Security....................... 757,750
</TABLE>
<TABLE>
<CAPTION>
VALUE
SHARES/PAR (NOTE 1)
- ---------- --------
<C> <S> <C>
810 La Salle National Corporation,
6.46% Pfd. .................... $ 893,025
35,500 NB Capital Trust,
7.84% TOPRS.................... 916,344
1,950,000 Republic NY Capital,
7.53% 12/4/26 Capital
Security....................... 2,030,438
6,300 Republic New York Corporation,
5.715% Pfd. ................... 329,963
1,000,000 Summit Bancorp,
8.40% 3/15/27 Capital Security
144A** ........................ 1,111,250
------------
TOTAL BANKING FIXED RATE
PREFERRED STOCKS AND
SECURITIES..................... 27,423,630
------------
FINANCIAL SERVICES -- 12.3 %
41,700 Bear Stearns Co,
Series E, 6.15% Pfd. .......... 2,257,013
27,000 DLJ Capital Trust,
8.42% MIPS..................... 707,063
10,000 Heller Financial,
6.687% Pfd. 144A** ............ 1,107,500
133,300 Household International, Inc.,
8.70% TOPRS.................... 3,540,781
Lehman Brothers Holdings Inc.:
86,098 5.00% Conv. Pfd. ................ 3,153,339
62,988 Series A, 8.30% QUICS............ 1,633,751
52,000 Series C, 5.94% Pfd. ............ 2,743,000
Merrill Lynch & Company, Inc.:
24,900 8.00% TOPRS...................... 664,519
90,600 Series A, 9.00% Pfd. ............ 2,904,863
Travelers Group:
6,500 Series G, 6.213% Pfd. ........... 355,063
82,950 Series H, 6.231% Pfd. ........... 4,572,619
72,485 Series M, 5.864% Pfd. ........... 3,823,584
------------
TOTAL FINANCIAL SERVICES FIXED
RATE PREFERRED STOCKS AND
SECURITIES..................... 27,463,095
------------
INSURANCE -- 8.4 %
3,400,000 Allstate Financing,
7.83% 12/01/45 Capital
Security....................... 3,608,250
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
MAY 31, 1998 (UNAUDITED)
---------------------------------------------------------------
<TABLE>
<CAPTION>
VALUE
SHARES/PAR (NOTE 1)
- ---------- --------
<C> <S> <C>
PREFERRED STOCKS AND SECURITIES (CONTINUED)
FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
INSURANCE (CONTINUED)
300,000 American General Capital,
7.57% Capital Security
144A** ........................ $ 317,625
63,481 Hartford Capital, Series B, 8.35%
QUIPS.......................... 1,686,214
4,200,000 MMI Capital Trust,
Series B, 7.625% 12/15/27
Capital Security............... 4,320,750
4,000,000 Orion Capital Trust,
7.701% 4/15/28 Capital Security
144A** ........................ 4,115,000
1,000,000 Provident Companies Inc.,
7.405% 3/15/38 Capital
Security....................... 1,022,500
35 Prudential Human Resources
Management Company,
6.30% Private, Sinking Fund
Pfd............................ 3,561,250
------------
TOTAL INSURANCE FIXED RATE
PREFERRED STOCKS AND
SECURITIES..................... 18,631,589
------------
MISCELLANEOUS INDUSTRIES -- 6.2 %
118,300 Coastal Finance,
8.375%, TOPRS.................. 2,964,894
55,000 Farmland Industries Inc.,
8.00% Pfd. 144A** ............. 3,478,750
3,600 Time Warner Inc.,
Series M, 10.25% Pfd. ......... 4,165,200
19,700 Union Texas Petro Holdings,
Series A, 7.14% Pfd. .......... 2,430,488
9,520 Viad Corporation,
$4.75 Sinking Fund Pfd. ....... 754,460
------------
TOTAL MISCELLANEOUS FIXED RATE
PREFERRED STOCKS AND
SECURITIES..................... 13,793,792
------------
TOTAL FIXED RATE PREFERRED STOCKS
AND SECURITIES................. 155,062,354
------------
TOTAL PREFERRED STOCKS
AND SECURITIES
(Cost $195,097,240)............ 213,950,256
------------
</TABLE>
<TABLE>
<CAPTION>
VALUE
SHARES/PAR (NOTE 1)
- ---------- --------
<C> <S> <C>
COMMON STOCKS -- 2.3 %
UTILITIES -- 2.3 %
3,000 Energy East Corporation.......... $ 122,250
30,000 Nevada Power Company............. 719,063
20,000 New England Electric System...... 837,500
11,200 Northern States Power Company.... 635,950
32,000 Scana Corporation................ 924,000
47,100 Wisconsin Energy Corporation..... 1,392,394
16,700 WPS Resources Corporation........ 522,919
------------
TOTAL UTILITY COMMON STOCKS
(Cost $4,632,336).............. 5,154,076
------------
MISCELLANEOUS SECURITIES -- 0.3 % (Cost $1,496,137)
September Put Options on U.S.
Treasury Bond Futures, expiring
8/22/98+....................... 632,219
------------
</TABLE>
<TABLE>
<C> <S> <C>
COMMERCIAL PAPER -- 0.4 % (Cost $894,000)
$894,000 General Electric Capital
Corporation, 5.66% due
06/01/98........................ 894,000
------------
TOTAL INVESTMENTS (Cost $202,119,713*)... 99.2% 220,630,551
OTHER ASSETS AND LIABILITIES (Net)....... 0.8 1,883,071
----- ------------
NET ASSETS...............................100.0% $222,513,622
===== ============
</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.
+ Non-income producing.
<TABLE>
<S> <C>
ABBREVIATIONS (Note 6):
TOPRS -- Trust Originated Preferred Securities
QUIPS -- Quarterly Income Preferred Securities
MIPS -- Monthly Income Preferred Securities
QUIDS -- Quarterly Income Debt Securities
COPRS -- Canadian Originated Preferred Securities
QUICS -- Quarterly Income Capital Securities
QUIBS -- Quarterly Interest Bonds
Capital Securities are debt instruments and the amounts
shown in the Shares/Par column are dollar amounts of par
value.
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
STATEMENT OF ASSETS AND LIABILITIES
MAY 31, 1998 (UNAUDITED)
- -------------------------------------------------------------
<TABLE>
<S> <C> <C>
ASSETS:
Investments, at value (Cost $202,119,713) (Note 1)
See accompanying schedule.............................. $220,630,551
Cash...................................................... 148
Receivable for securities sold............................ 1,695,480
Dividends and interest receivable......................... 1,783,349
Prepaid expenses.......................................... 62,515
------------
Total Assets...................................... 224,172,043
LIABILITIES:
Payable for securities purchased.......................... $ 1,064,531
Dividends payable to Common Shareholders.................. 246,422
Investment advisory fee payable (Note 2).................. 104,837
Accrued expenses and other payables....................... 242,631
-----------
Total Liabilities................................. 1,658,421
------------
NET ASSETS.................................................. $222,513,622
============
NET ASSETS consist of:
Accumulated distributions in excess of net investment
income (Note 1)........................................ $ (234,498)
Accumulated net realized gain on investments sold (Note
1)..................................................... 4,883,323
Unrealized appreciation of investments (Note 3)........... 18,510,838
Par value of Common Stock................................. 98,386
Paid-in capital in excess of par value of Common Stock.... 141,755,573
Money Market Cumulative Preferred(TM) Stock (Note 5)...... 57,500,000
------------
Total Net Assets.................................. $222,513,622
============
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......................... 45.83 26,354
----------- ------------
$100,045.83 57,526,354
===========
Common Stock (9,838,571 shares outstanding)............... $16.77 164,987,268
====== ------------
TOTAL NET ASSETS............................................ $222,513,622
============
</TABLE>
See Notes to Financial Statements.
12
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MAY 31, 1998 (UNAUDITED)
---------------------------------------------------------------
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Dividends.............................................. $ 6,096,886
Interest............................................... 1,178,269
-----------
Total Investment Income........................... 7,275,155
EXPENSES:
Investment advisory fee (Note 2)....................... $614,004
Administration fee (Note 2)............................ 132,402
Money Market Cumulative Preferred(TM) broker
commissions and Auction Agent fees.................... 73,073
Legal and audit fees................................... 58,104
Shareholder servicing agent fees (Note 2).............. 49,882
Insurance expense...................................... 38,961
Directors' fees and expenses (Note 2).................. 30,141
Economic consulting fee (Note 2)....................... 22,667
Custodian fees (Note 2)................................ 16,068
Other.................................................. 78,754
--------
Total Expenses.................................... 1,114,056
-----------
NET INVESTMENT INCOME....................................... 6,161,099
-----------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
(Notes 1 and 3):
Net realized gain on investments sold during the
period................................................ 3,919,328
Change in net unrealized appreciation of investments
during the period..................................... 408,861
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS............. 4,328,189
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $10,489,288
===========
</TABLE>
See Notes to Financial Statements.
13
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
STATEMENT OF CHANGES IN NET ASSETS
- ---------------------------------------------------------------
<TABLE>
<CAPTION>
SIX MONTHS ENDED
MAY 31, 1998 YEAR ENDED
(UNAUDITED) NOVEMBER 30, 1997
---------------- -----------------
<S> <C> <C>
OPERATIONS:
Net investment income.................................. $ 6,161,099 $ 12,471,063
Net realized gain on investments sold during the
period............................................... 3,919,328 3,916,069
Change in net unrealized appreciation of investments
during the period.................................... 408,861 5,935,201
------------ ------------
Net increase in net assets resulting from operations... 10,489,288 22,322,333
DISTRIBUTIONS:
Dividends paid from net investment income to Money
Market Cumulative Preferred(TM) Stock Shareholders
(Note 5)............................................. (1,409,021) (2,117,616)
Distributions paid from net realized capital gains to
Money Market Cumulative Preferred(TM) Stock
Shareholders (Note 5)................................ (46,436) (622,495)
Dividends paid from net investment income to Common
Stock Shareholders................................... (5,595,194) (11,293,196)
Distributions paid from net realized capital gains to
Common Stock Shareholders............................ (2,915,169) (6,386,813)
------------ ------------
NET INCREASE IN NET ASSETS FOR THE PERIOD................... 523,468 1,902,213
------------ ------------
NET ASSETS:
Beginning of period.................................... 221,990,154 220,087,941
------------ ------------
End of period (including accumulated distributions in
excess of net investment income and undistributed net
investment income of $(234,498) and $608,618,
respectively)........................................ $222,513,622 $221,990,154
============ ============
</TABLE>
See Notes to Financial Statements.
14
<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 NOVEMBER 30,
MAY 31, 1998 --------------------------------------------------------
(UNAUDITED) 1997 1996 1995 1994 1993
------------ -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
OPERATING PERFORMANCE:
Net asset value, beginning of period................... $ 16.71 $ 16.50 $ 15.80 $ 14.74 $ 18.39 $ 18.59
-------- -------- -------- -------- -------- --------
Net investment income.................................. 0.63 1.27 1.37 1.48 1.42 1.48
Net realized and unrealized gain/(loss) on
investments........................................... 0.43 1.00 0.65 2.05 (2.06) 1.37
-------- -------- -------- -------- -------- --------
Net increase/(decrease) in net asset value............. 1.06 2.27 2.02 3.53 (0.64) 2.85
-------- -------- -------- -------- -------- --------
DISTRIBUTIONS:
Dividends paid from net investment income to MMP*
Shareholders.......................................... (0.14) (0.22) (0.15) (0.26) (0.16) (0.12)
Distributions paid from net realized capital gains to
MMP* Shareholders..................................... (0.00)# (0.06) (0.08) (0.01) (0.07) (0.07)
Dividends paid from net investment income to Common
Stock Shareholders.................................... (0.57) (1.15) (1.08) (1.36) (1.15) (1.34)
Distributions paid from net realized capital gains to
Common Stock Shareholders............................. (0.30) (0.65) -- (0.83) (1.64) (1.51)
Change in accumulated undeclared dividends on MMP*..... 0.01 0.02 (0.01) (0.01) 0.01 (0.01)
-------- -------- -------- -------- -------- --------
Total Distributions.................................... (1.00) (2.06) (1.32) (2.47) (3.01) (3.05)
-------- -------- -------- -------- -------- --------
Net asset value, end of period......................... $ 16.77 $ 16.71 $ 16.50 $ 15.80 $ 14.74 $ 18.39
======== ======== ======== ======== ======== ========
Market value, end of period............................ $ 15.938 $ 16.188 $ 15.500 $ 14.125 $ 13.500 $ 18.375
======== ======== ======== ======== ======== ========
Total investment return based on net asset value***.... 5.80% 13.65% 12.78% 25.13% (5.22)% 15.54%
======== ======== ======== ======== ======== ========
Total investment return based on market value***....... 3.80% 17.20% 18.50% 22.14% (13.12)% 9.33%
======== ======== ======== ======== ======== ========
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK
SHAREHOLDERS:
Operating expenses.................................. 1.36%** 1.34% 1.51% 1.55% 1.52% 1.50%
Net investment income****........................... 5.88%** 6.22% 7.22% 8.33% 7.55% 7.33%
SUPPLEMENTAL DATA:
Portfolio turnover rate............................. 52% 74% 98% 94% 98% 110%
Net assets, end of period (in 000's)................ $222,514 $221,990 $220,088 $213,053 $199,386 $225,896
- ----------------------------------------------------
Ratio of operating expenses to Total Average Net Assets
including MMP*........................................ 1.01%** 0.99% 1.10% 1.11% 1.11% 1.11%
</TABLE>
* Money Market Cumulative Preferred(TM) Stock.
** Annualized.
*** Assumes reinvestment of distributions at the price obtained by the Fund's
Dividend Reinvestment Plan.
**** The net investment income ratios reflect income net of operating expenses
and payments to MMP* Shareholders.
# Amount represents less than $0.01 per share.
See Notes to Financial Statements.
15
<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>
05/31/98* 575 $386,946 $100,000 $100,000
11/30/97 575 386,070 100,000 100,000
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.
* Unaudited.
See Notes to Financial Statements.
16
<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
17
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
interest. The Fund maintains possession of the collateral 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.
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. Subject to the Fund qualifying as a regulated
investment company, any taxes paid by the Fund on such net realized long-term
gains may be used by the Fund's Shareholders as a credit against their own tax
liabilities.
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 and capital gain distributions are determined and characterized in
accordance with income tax regulations which may differ from generally accepted
accounting principles. 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 proportional allocation of income and gains to all classes of
Shareholders.
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.
Other: 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
18
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
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.
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, 1998, excluding short-term investments, aggregated $112,383,033
and $118,165,142, respectively.
At May 31, 1998, aggregate gross unrealized appreciation for all securities
in which there is an excess of value over cost was $19,402,295 and aggregate
gross unrealized depreciation for all securities in which there is an excess of
cost over value was $891,457.
4. COMMON STOCK
At May 31, 1998, 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, 1998 and the year ended November 30, 1997.
19
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
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.
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 is 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, 1998, 575 shares of Money Market Cumulative Preferred(TM) Stock
were outstanding at the annual rate of 4.125%. 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. PORTFOLIO INVESTMENTS, CONCENTRATION AND INVESTMENT QUALITY
The Fund invests primarily in adjustable and fixed rate preferred
securities. Under normal market conditions, the Fund invests at least 25% of its
assets in securities issued by utilities and at least 25% of
20
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------
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
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"), Quarterly Income Capital Shares ("QUICS"), and similarly-structured
instruments commonly referred to as hybrid or taxable preferreds, subject to the
quality standards set forth above. The Fund's investment policy was further
amended on October 17, 1997, to clarify that the foregoing 35% limitation only
applies to such TOPRS, MIPS, QUIDS, QUIPS, COPRS, QUICS and analogous securities
that the Fund's Adviser deems to be debt-like in key characteristics.
7. 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, 1998, 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.
21
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
QUARTERLY RESULTS OF INVESTMENT OPERATIONS (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
AVAILABLE TO COMMON STOCK SHAREHOLDERS
----------------------------------------------------------------------
NET REALIZED NET INCREASE/
AND UNREALIZED (DECREASE) IN
GAIN/(LOSS) NET ASSETS FROM
INVESTMENT INCOME NET INVESTMENT 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>
02/28/96 $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 0.29 366,250 0.04 3,287,742 0.33
05/31/97 3,693,092 0.38 3,207,492 0.33 2,423,903 0.25 5,631,395 0.58
08/31/97 3,698,518 0.38 3,143,252 0.32 4,708,452 0.47 7,851,704 0.79
11/30/97 3,756,306 0.38 3,198,827 0.33 2,352,665 0.24 5,551,492 0.57
02/28/98 3,722,217 0.38 3,172,006 0.32 2,143,192 0.22 5,315,198 0.54
05/31/98 3,552,938 0.36 2,989,093 0.31 2,184,997 0.21 5,174,090 0.52
</TABLE>
- ---------------
* Per share of common stock.
22
<PAGE>
- --------------------------------------------------------------------------------
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 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, 1998,
$4,255 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
23
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- ------------------------------------------------------------------------------
payment date, a dividend or distribution in an amount equal to the cash that the
participant could have received instead of shares.
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.
24
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
------------------------------------------------------------------------------
MEETING OF SHAREHOLDERS
On April 17, 1998, the Fund held its Annual Meeting of Shareholders (the
"Meeting") to (1) elect two Directors of the Fund ("Proposal 1"), (2) ratify the
selection of Coopers & Lybrand L.L.P. as independent accountants for the Fund
for the fiscal year ending November 30, 1998 ("Proposal 2"), and (3) approve an
amendment to the Fund's Articles of Incorporation to require a "super-majority"
vote to change the Fund's investment objective, its diversified status or its
policy against investing for the purpose of gaining control of a company
("Proposal 3"). With respect to Proposal 3, the Meeting was adjourned and
reconvened on May 15, 1998. The results of each proposal are as follows:
PROPOSAL 1: ELECTION OF DIRECTORS.
<TABLE>
<CAPTION>
NAME FOR WITHHELD UNVOTED
- ---- --- -------- -------
<S> <C> <C> <C>
Common Stock
Robert T. Flaherty........................................ 9,263,359 152,594 --
Preferred Stock
Morgan Gust............................................... 397 -- --
</TABLE>
Martin Brody, Donald F. Crumrine, David Gale and Robert F. Wulf continue to
serve in their capacities as Directors of the Fund.
PROPOSAL 2: RATIFY THE SELECTION OF COOPERS & LYBRAND L.L.P. AS INDEPENDENT
ACCOUNTANTS.
<TABLE>
<CAPTION>
FOR AGAINST ABSTAINED
--- ------- ---------
<S> <C> <C> <C>
Common Stock and Preferred Stock
(voting together as a single class)
Voted....................................................... 9,235,372 54,021 126,958
</TABLE>
PROPOSAL 3: APPROVE AN AMENDMENT TO THE FUND'S ARTICLES OF INCORPORATION.
<TABLE>
<CAPTION>
FOR AGAINST ABSTAINED
--- ------- ---------
<S> <C> <C> <C>
Common Stock
(voting as a single class)
Voted....................................................... 5,101,818 145,713 199,671
Preferred Stock
(voting as a single class)
Voted....................................................... 356 -- 41
</TABLE>
25
<PAGE>
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 4/98
[Preferred Income Fund]
Semi-Annual
Report
May 31, 1998
