<PAGE>
PREFERRED INCOME FUND INCORPORATED
Dear Shareholder:
The bottom line for the fiscal first quarter ending February 28, 1999
was that the Preferred Income Fund's portfolio made money in a market that most
fixed income investors found difficult. The return on the net asset value
("NAV") of the Fund's shares was 0.8% for the quarter and 4.5% for the last
twelve months, taking into account the special distribution of $0.76 per share
paid to shareholders on December 31, 1998.
Interest rates have again demonstrated their ability to confound the
so-called experts. Just when everyone "knew" that rates would go down, interest
rates spiked up in February, returning roughly to the levels of last summer.
This time the surprise was the strength in the domestic economy, which pushed
aside the market's previous preoccupation with depressed economic conditions
elsewhere around the world. Perhaps all this proves is that the crystal ball is
basically an inferior tool for dealing with interest rate fluctuations.
Rising interest rates caused the prices of most bonds and preferreds to
fall, but there was little visible impact on the Fund because of the gains on
our hedges. As a reminder, we typically hedge by purchasing put options on
Treasury futures and creating a "safety net" that is initially somewhat below
the level of the market. For the hedge to pay off, rising interest rates must
push market values down enough to reach that safety net. That is exactly what
happened in February.
Strange as it may seem, it helps us when interest rates move suddenly
in EITHER direction. Throughout its history, the Fund has typically turned in
strong performance in good markets and held up well in weak markets. This is at
least partially due to the combination of leverage and hedging used by the Fund.
We actually distinguish ourselves least in flat, boring markets, but markets
like that, fortunately, never seem to last very long!
The preferred market also gave us a helping hand in the fiscal first
quarter by generally outperforming Treasury bonds, on which our hedges are
based. This allowed us to regain some of the ground lost last year when
preferreds trailed Treasuries during the "flight to quality" caused by
international financial fears. Market activity has improved significantly since
then, and we are coming across many interesting investment opportunities.
The discount of the market price of the Fund's shares from their NAV
widened rather suddenly to roughly 10% near the end of the fiscal first quarter.
This has happened before as interest rates have surged and bond and preferred
prices have weakened. So far, at least, the market does not seem to be paying
much attention to the remarkable stability of the Fund's NAV throughout this
period of stress.
Sincerely
/s/ Robert T. Flaherty
Robert T. Flaherty
CHAIRMAN OF THE BOARD
March 15, 1999
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Preferred Income Fund Incorporated
SUMMARY OF INVESTMENTS
FEBRUARY 28, 1999 (UNAUDITED)
- -------------------------------------
<TABLE>
<CAPTION>
PERCENT OF
VALUE TOTAL NET
(000'S) ASSETS
-------- ----------
<S> <C> <C>
ADJUSTABLE RATE PREFERRED STOCKS
Banking ...................................................................... $ 25,626 12.1%
Utilities .................................................................... 9,468 4.5
-------- -----
Total Adjustable Rate .................................................... 35,094 16.6
-------- -----
FIXED RATE PREFERRED STOCKS AND SECURITIES
Utilities .................................................................... 59,229 28.0
Banking ...................................................................... 45,390 21.5
Financial Services ........................................................... 24,984 11.8
Insurance .................................................................... 20,413 9.6
Miscellaneous Industries ..................................................... 17,129 8.1
-------- -----
Total Fixed Rate ......................................................... 167,145 79.0
-------- -----
TOTAL PREFERRED STOCKS AND SECURITIES ........................................... 202,239 95.6
COMMON STOCKS
Utilities .................................................................... 265 0.1
REPURCHASE AGREEMENT ............................................................. 3,984 1.9
PURCHASED PUT OPTIONS ............................................................ 5,066 2.4
-------- -----
TOTAL INVESTMENTS ................................................................ 211,554 100.0
OTHER ASSETS AND LIABILITIES (NET) ............................................... 82 0.0#
-------- -----
TOTAL NET ASSETS ......................................................... $211,636 100.0%
======== =====
</TABLE>
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, 1998 ........................... $0.7600 $15.73 $15.5625 $15.54
January 31, 1999 ............................ 0.0785 15.62 14.7500 14.87
February 28, 1999 ........................... 0.0785 15.65 14.0625 14.23
</TABLE>
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(1) Whenever the net asset value per share of the Fund's common stock is less
than or equal to the market price per share on the payment date, new shares
issued will be valued at the higher of net asset value or 95% of the then
current market price. Otherwise, the reinvestment shares of common stock
will be purchased in the open market.
# Amount represents less than 0.1% of net assets.
2
<PAGE>
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Preferred Income Fund Incorporated
STATEMENT OF CHANGES IN NET ASSETS(1)
THREE MONTHS ENDED FEBRUARY 28, 1999 (UNAUDITED)
-----------------------------------------------------
<TABLE>
<S> <C>
OPERATIONS:
Net investment income ........................................................................ $ 3,077,285
Net realized gain on investments sold ........................................................ 371,699
Net unrealized depreciation of investments during the period ................................. (1,151,219)
------------
Net increase in net assets from operations ............................................... 2,297,765
DISTRIBUTIONS:
Dividends paid from net investment income to MMP* shareholders ............................... (900,948)
Distributions paid from net realized capital gains to MMP* Shareholders(3) ................... (136,553)
Dividends paid from net investment income to Common Stock Shareholders(2) .................... (4,449,002)
Distributions paid from net realized capital gains to Common Stock Shareholders(3) ........... (4,572,968)
NET DECREASE IN NET ASSETS: ...................................................................... (7,761,706)
NET ASSETS:
Beginning of period .......................................................................... 219,397,924
------------
End of period ................................................................................ $211,636,218
============
</TABLE>
FINANCIAL HIGHLIGHTS(1)
THREE MONTHS ENDED FEBRUARY 28, 1999 (UNAUDITED)
FOR A COMMON SHARE OUTSTANDING THROUGHOUT THE PERIOD.
-----------------------------------------------------
<TABLE>
<S> <C>
OPERATING PERFORMANCE:
Net asset value, beginning of period ......................................................... $ 16.43
----------
Net investment income ........................................................................ 0.31
Net realized gain and unrealized depreciation on investments ................................. (0.09)
----------
Net increase in net asset value resulting from investment operations ......................... 0.22
DISTRIBUTIONS:
Dividends paid from net investment income to MMP* Shareholders ............................... (0.09)
Distributions paid from net realized capital gains to MMP* Shareholders(3) ................... (0.01)
Dividends paid from net investment income to Common Stock Shareholders(2) .................... (0.45)
Distributions paid from net realized capital gains to Common Stock Shareholders(3) ........... (0.46)
Change in accumulated undeclared dividends on MMP* ........................................... 0.01
----------
Total distributions .......................................................................... (1.00)
----------
Net asset value, end of period ............................................................... $ 15.65
==========
Market value, end of period .................................................................. $ 14.0625
==========
Common shares outstanding, end of period ..................................................... 9,838,571
==========
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK SHAREHOLDERS:
Net investment income (4) .................................................................... 5.54%**
Operating expenses ........................................................................... 1.37%**
SUPPLEMENTAL DATA:
Portfolio turnover rate ...................................................................... 14%
- --------------------------------------------------------------------------------------------------
Ratio of operating expenses to total average net assets including MMP* ........................... 1.00%**
</TABLE>
(1) These tables summarize the three months ended February 28, 1999 and should
be read in conjunction with the Fund's audited financial statements,
including footnotes, in its Annual Report for the year ended November 30,
1998.
(2) Includes dividends earned, but not paid out, in prior fiscal year.
(3) Paid from capital gains realized, but not paid out, in prior fiscal year.
(4) Not necessarily reflective of results on an annual basis due to impact of
Fiscal 1998 Additional Distributions to MMP*, all of which were paid in the
first quarter of Fiscal 1999.
* Money Market Cumulative Preferred(TM) Stock.
** Annualized.
3
<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
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.
[Preferred Income Fund Logo]
Quarterly
Report
February 28, 1999
