PREFERRED INCOME FUND INCORPORATED
Dear Shareholder:
The Preferred Income Fund got off to a terrific start during the first
quarter of fiscal 2003. For the three months ending February 28th, the Fund
earned 9.8% on Net Asset Value and 12.4% on the market value of its shares.
During the same period, the Lipper US Government Fund Index rose 3.9% and the
Lipper BBB Rated Corporate Debt Index was up 5.6%. There were several factors
underpinning the strong performance of the Fund, but one in particular stands
out.
The centerpiece of the Bush Administration's Jobs and Growth Package
announced in early January is a proposal to eliminate the double taxation of
dividends. Under current law, corporate earnings may be subject to two levels of
taxation - one at the corporate level and once again at the shareholder level.
The Administration believes that multiple taxation of corporate profits
increases the cost of capital and creates "severe economic distortions". Some in
Congress, however, have expressed doubt about the wisdom and timing of the
President's proposals. In the parlance of Washington, this means there will be
some serious horse-trading in the coming months, and the eventual outcome is
very much up in the air.
Preferred securities can be divided into two basic types - traditional
preferreds, which pay dividends, and taxable or "hybrid" preferreds, which pay
interest. If enacted, the Administration's proposal would directly impact
holders of traditional preferreds only. Not surprisingly, since the proposal was
announced traditional preferreds have turned in the best performance.
As discussed in previous letters, over the past several quarters we have
been increasing the portfolio's allocation to traditional preferreds. Some might
assume that the shift was in anticipation of what might come out of Washington.
Not so! The actual reason for the reallocation was based on the same
decision-making process employed consistently throughout the life of the Fund.
We have felt that in recent months, the yield levels on traditional preferreds
have been more attractive than other segments of the market. We considered this
an aberration and therefore a great opportunity to purchase undervalued
securities. Regardless of the legislative outcome, traditional preferreds still
look attractive by most historical measures, and we are very comfortable with
the current composition of the investment portfolio.
The historically low level of interest rates in the United States presents
some challenges as we strive to maintain the current level of income produced
from the assets in the portfolio. Sustained low levels of rates could ultimately
result in issuers refinancing higher yielding securities with lower coupon
issues much like homeowners refinance a mortgage.
Two of our basic investment approaches should help ward off this income
erosion. First, we always attempt to buy undervalued securities. If we are
right, the Fund will have more money to invest in additional income producing
securities. Second, we generally avoid those securities that pay a high dividend
rate but have a greater likelihood of being redeemed by the issuer in the near
future. Such issues provide short-term gratification but long-term pain if the
investor is forced to reinvest in a lower interest rate environment.
The strategy has been generally effective thus far, but the challenge will
increase if interest rates continue to fall and remain low for an extended
period of time. The first quarter will be a tough act to follow, but you can
count on us to stick to our strategy and provide you with candid assessments of
our progress.
Sincerely,
/S/ DONALD F. CRUMRINE /S/ ROBERT M. ETTINGER
Donald F. Crumrine Robert M. Ettinger
CHAIRMAN OF THE BOARD PRESIDENT
March 20, 2003
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Preferred Income Fund Incorporated
SUMMARY OF INVESTMENTS
FEBRUARY 28, 2003 (UNAUDITED)
----------------------------------
PERCENT
VALUE OF TOTAL
(000'S) NET ASSETS
-------- ----------
ADJUSTABLE RATE PREFERRED SECURITIES
Utilities .................................................. $ 367 0.2%
Banking .................................................... 20,625 9.1
Financial Services ......................................... 520 0.2
-------- -----
Total Adjustable Rate .................................. 21,512 9.5
-------- -----
FIXED RATE PREFERRED SECURITIES
Utilities .................................................. 85,354 37.7
Banking .................................................... 42,127 18.6
Financial Services ......................................... 33,779 14.9
Insurance .................................................. 19,181 8.5
Oil and Gas ................................................ 7,940 3.5
Miscellaneous Industries ................................... 5,651 2.5
-------- -----
Total Fixed Rate ....................................... 194,032 85.7
-------- -----
INVERSE FLOATING RATE PREFERRED SECURITIES ...................... 1,852 0.8
TOTAL PREFERRED STOCKS AND SECURITIES ........................... 217,396 96.0
DEBT SECURITIES ................................................. 2,086 0.9
COMMON STOCKS ................................................... 3,049 1.3
PURCHASED PUT OPTIONS ........................................... 1,848 0.8
MONEY MARKET FUNDS .............................................. 1,652 0.7
-------- -----
TOTAL INVESTMENTS ............................................... 226,031 99.7
OTHER ASSETS AND LIABILITIES (NET) .............................. 716 0.3
-------- -----
TOTAL NET ASSETS AVAILABLE TO COMMON AND PREFERRED STOCK ... $226,747 100.0%
======== =====
FINANCIAL DATA
PER SHARE OF COMMON STOCK (UNAUDITED)
--------------------------------------------------------
DIVIDEND
DIVIDENDS NET ASSET NYSE REINVESTMENT
PAID VALUE CLOSING PRICE PRICE (1)
--------- --------- ------------- ------------
December 31, 2002 - Regular ...................... $0.0915 $13.65 $15.10 $14.35
December 31, 2002 - Extra ........................ 0.1285 13.65 15.10 14.35
January 31, 2003 ................................. 0.0915 14.45 16.70 15.87
February 28, 2003 ................................ 0.0915 14.55 16.42 15.60
--------------------
(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.
2
--------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS AVAILABLE TO COMMON STOCK(1)
THREE MONTHS ENDED FEBRUARY 28, 2003 (UNAUDITED)
---------------------------------------------------------------
VALUE
(000'S)
-------
OPERATIONS:
Net investment income .............................................................. $ 3,278
Net realized loss on investments sold during the period ............................ (1,569)
Net unrealized appreciation of investments during the period ....................... 11,875
Distributions to Money Market Cumulative Preferred(TRADE MARK)
Stock (MMP(TRADE MARK)) Shareholders from net investment
income, including changes in accumulated undeclared distributions .............. (334)
Decrease due to MMP(TRADE MARK) offering cost adjustment ........................... (6)
--------
Net increase in net assets from operations ..................................... 13,244
DISTRIBUTIONS:
Dividends paid from net investment income to Common Stock Shareholders(2) .......... (4,054)
Distributions paid from net realized capital gains to Common Stock Shareholders .... --
--------
Total Distributions ............................................................ (4,054)
FUND SHARES TRANSACTIONS:
Increase from Common Stock Transactions ............................................ 720
--------
NET INCREASE IN NET ASSETS AVAILABLE TO COMMON STOCK FOR THE PERIOD ..................... 9,910
NET ASSETS AVAILABLE TO COMMON STOCK:
Beginning of period ................................................................ 136,756
--------
End of period ...................................................................... $146,666
========
FINANCIAL HIGHLIGHTS(1)
THREE MONTHS ENDED FEBRUARY 28, 2003 (UNAUDITED)
FOR A COMMON SHARE OUTSTANDING THROUGHOUT THE PERIOD.
-----------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period .............................................. $ 13.63
-----------
INVESTMENT OPERATIONS:
Net investment income ............................................................. 0.32
Net realized gain and unrealized appreciation on investments ...................... 1.03
DISTRIBUTIONS TO MMP(TRADE MARK) SHAREHOLDERS:
From net investment income (including change in accumulated
undeclared dividends on MMP(TRADE MARK)) ......................................... (0.03)
From net realized capital gains .................................................. 0.00
-----------
Total from investment operations ................................................. 1.32
-----------
DISTRIBUTIONS TO COMMON SHAREHOLDERS:
From net investment income ....................................................... (0.40)
From net realized capital gains .................................................. 0.00
-----------
Total distributions to Common Shareholders ....................................... (0.40)
-----------
Net asset value, end of period ................................................... $ 14.55
===========
Market value, end of period ...................................................... $ 16.42
===========
Common shares outstanding, end of period ......................................... $10,081,681
===========
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK SHAREHOLDERS:
Net investment income ............................................................. 8.27%*
Operating expenses ................................................................ 1.51%*
--------------------------------------------------------
SUPPLEMENTAL DATA:++
Portfolio turnover rate fiscal year to date ....................................... 6%
Total net assets available to Common and Preferred Stock, end of period (in 000's). $ 226,747
Ratio of operating expenses to total average net assets including MMP(TRADE MARK).. 0.97%*
(1) These tables summarize the three months ended February 28, 2003 and should be read in conjunction with the Fund's audited
financial statements, including footnotes, in its Annual Report dated November 30, 2002.
(2) Includes income earned, but not paid out, in prior fiscal year.
* Annualized.
++ Information presented under heading Supplemental Data includes MMP(TRADE
MARK).
3
DIRECTORS
Martin Brody
Donald F. Crumrine, CFA
Robert M. Ettinger, CFA
David Gale
Morgan Gust
Robert F. Wulf, CFA
OFFICERS
Donald F. Crumrine, CFA
Chairman of the Board
and Chief Executive Officer
Robert M. Ettinger, CFA
President and Secretary
Peter C. Stimes, CFA
Vice President, Treasurer,
Chief Financial and
Accounting Officer
Robert E. Chadwick, CFA
Assistant Treasurer
INVESTMENT ADVISER
Flaherty & Crumrine Incorporated
e-mail: flaherty@fin-mail.com
QUESTIONS CONCERNING YOUR SHARES OF PREFERRED
INCOME FUND?
o If your shares are held in a brokerage account,
contact your broker.
o If you have physical possession of your shares in certificate form,
contact the Fund's Transfer Agent & Shareholder Servicing Agent --
PFPC Inc.
P.O. Box 43027
Providence, RI 02940-3027
1-800-331-1710
THIS REPORT IS SENT TO SHAREHOLDERS OF PREFERRED INCOME FUND INCORPORATED FOR
THEIR INFORMATION. IT IS NOT A PROSPECTUS, CIRCULAR OR REPRESENTATION INTENDED
FOR USE IN THE PURCHASE OR SALE OF SHARES OF THE FUND OR OF ANY SECURITIES
MENTIONED IN THIS REPORT.
[LOGO OMITTED - PREFERRED INCOME FUND]
Quarterly
Report
February 28, 2003
web site: www.preferredincome.com