UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-06495
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
(Exact name of registrant as specified in charter)
301 E. Colorado Boulevard, Suite 720
Pasadena, CA 91101
(Address of principal executive offices) (Zip code)
Donald F. Crumrine
Flaherty & Crumrine Incorporated
301 E. Colorado Boulevard, Suite 720
Pasadena, CA 91101
(Name and address of agent for service)
registrant's telephone number, including area code: 626-795-7300
Date of fiscal year end: November 30
Date of reporting period: November 30, 2010
Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. Section 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
FLAHERTY & CRUMRINE PREFERRED INCOME OPPORTUNITY FUND
To the Shareholders of Flaherty & Crumrine Preferred Income Opportunity Fund:
We begin with good news about distributions on your shares of PFO--the Fund
finished fiscal 2010 with a bit of extra income, so shareholders of record on
December 23, 2010 received an additional $0.03 per share. In addition, the
regular monthly distribution was increased to $0.0735 from $0.0725 per share
beginning with the December dividend(1).
During the Fund's final fiscal quarter, the portfolio once again turned in
solid performance. For the three-month period ending November 30, 2010, the
Fund's return on net asset value was +6.2%. Over the entire fiscal year, the
return on NAV was +32.4%. The table below presents these and other performance
measures of interest to investors.
TOTAL RETURN ON NET ASSET VALUE
FOR PERIODS ENDED NOVEMBER 30, 2010
ACTUAL RETURNS AVERAGE ANNUALIZED RETURNS
---------------------- -------------------------------
THREE SIX ONE THREE FIVE TEN LIFE OF
MONTHS MONTHS YEAR YEARS YEARS YEARS FUND(1)
------ ------ ---- ----- ----- ----- -------
Flaherty & Crumrine Preferred
Income Opportunity Fund ............. 6.2% 18.2% 32.4% 9.0% 4.3% 7.5% 8.6%
Barclays Capital U.S. Aggregate
Index(2) ............................ -0.1% 3.9% 6.0% 6.4% 6.2% 6.2% 6.7%
S&P 500 Index(3) ....................... 13.1% 9.5% 9.9% -5.2% 1.0% 0.8% 7.9%
----------
(1) Since inception on February 13, 1992.
(2) The Barclays Capital U.S. Aggregate Index represents securities that are
SEC-registered, taxable, and dollar denominated. The index covers the U.S.
investment grade fixed rate bond market, with index components for
government and corporate securities, mortgage pass-through securities, and
asset-backed securities. It is generally considered to be representative of
the domestic, investment-grade, fixed-rate, taxable bond market. Unless
otherwise noted, index returns reflect the reinvestment of dividends and
capital gains, if any, but do not reflect fees, brokerage commissions or
other expenses of investing. This index was formerly known as the Lehman
Brothers U.S. Aggregate Index.
(3) The S&P 500 is a capitalization-weighted index of 500 common stocks. The
index is designed to measure performance of the broad domestic economy
through changes in the aggregate market value of 500 stocks representing
all major industries.
The Fund's strong performance during the quarter was accomplished despite a
weak market for US Treasury bonds and continued uncertainty about changes in
regulation of the banking industry.
Conditions in the market for preferred securities are still positive.
Demand is broad based and steady, while most participants expect the size of the
market to decline (at least over the near-term). The market has also been
boosted by steady improvement in the financial strength of many issuers as,
corporate profitability has steadily improved.
----------
(1) A more in-depth discussion of the dividend and other important topics can
be found in the section which follows our letter.
SHORT-TERM interest rates remain near zero as economic activity remains
positive but stubbornly slow. Unemployment rates are high, and the impact of
fiscal and monetary actions has been more muted than desired. We anticipate
short-term interest rates (and hence the cost of the Fund's leverage) will
remain low over the near-term; however, eventually they will go up. Our view is
detailed in the Quarterly Economic Outlook available on the Fund's website.
Yields on LONG-TERM U.S. Treasury bonds increased almost 60 basis points
during the period; prices fell roughly 10%. Clearly, concerns about a pick-up in
economic activity, inflation, or both, have become more widespread. In the past,
a move of this magnitude typically caused some corresponding drop in the prices
of preferred securities. Obviously, the recent period was not typical--most
preferred prices actually went up in the face of falling bond prices. The
correlation between prices of preferred securities and treasury bonds used to be
reliably high, but this has not been the case for much of the past three years
(a major reason the Fund suspended its hedging strategy in autumn 2008).
As discussed previously, the financial crisis brought to light a need to
rethink the role of capital in the banking industry. Regulators and policy
makers are debating the amount and composition of capital necessary to prevent
a repeat of the crisis. Preferred securities play a very important part in the
debate. This is a complex matter and there are a lot of chefs in the kitchen; it
will likely take many more months before the process is complete. However, some
change is certain and we are managing the portfolio to reflect things we know
and some we anticipate. We remain optimistic the ultimate outcome will be
beneficial over the long term.
As always, we encourage you to visit www.preferredincome.com to read our
Quarterly Economic Update as well as a more detailed discussion of factors
affecting the wonderful world of preferred securities.
Sincerely,
/s/ Donald F. Crumrine /s/ Robert M. Ettinger
Donald F. Crumrine Robert M. Ettinger
Chairman President
January 10, 2011
2
DISCUSSION TOPICS
THE FUND'S PORTFOLIO RESULTS AND COMPONENTS OF TOTAL RETURN ON NAV
The table below reflects the performance of each investment technique
available for use by the Fund to achieve its objective, namely: (a) investing in
a portfolio of securities; (b) hedging that portfolio of securities against
significant increases in long-term interest rates (see the following discussion
on the status of the Fund's interest rate hedging strategy); and (c) utilizing
leverage to enhance returns to shareholders. Next, we compute the impact of the
Fund's operating expenses. All of the parts are summed to determine total return
on NAV.
COMPONENTS OF PFO'S TOTAL RETURN ON NAV
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 2010
SIX MONTHS* ONE YEAR
----------- --------
Total Return on Unleveraged Securities Portfolio
(including principal and income) ....................... +12.9% +23.0%
Return from Interest Rate Hedging Strategy ................ N/A N/A
Impact of Leverage (including leverage expense) ........... +6.1% +11.0%
Expenses (excluding leverage expense) ..................... -0.8% -1.6%
------ ------
TOTAL RETURN ON NAV .................................... +18.2% +32.4%
* Actual, not annualized.
The following table displays returns for the various segments of the
preferred securities market as measured by BofA Merrill preferred indices, over
both the past six months and the Fund's fiscal year ended November 30th. During
these periods, the preferred market continued the price recovery that began in
early 2009, but at a somewhat slower pace. As can be seen by comparing the total
return on the Fund's securities portfolio (the first row of the above table) to
the index results below, the Fund's portfolio outperformed all segments of the
preferred market over its fiscal year ending November 30th, even excluding the
impact of leverage. During the past six months, the Fund's (unleveraged)
securities portfolio outperformed all segments of the preferred market except
adjustable rate preferred securities, which constitute only about 2.5% of the
entire preferred market and just 2.8% of the Fund's portfolio.
TOTAL RETURNS OF BANK OF AMERICA MERRILL LYNCH PREFERRED SECURITIES INDICES*
FOR PERIODS ENDED NOVEMBER 30, 2010
SIX MONTHS* ONE YEAR
----------- --------
BofA Merrill Lynch 8% Capped DRD Preferred Stock Index(SM)................ +8.2% +16.9%
BofA Merrill Lynch 8% Capped Hybrid Preferred Securities Index(SM)........ +10.8% +18.8%
BofA Merrill Lynch 8% Capped Corporate U.S. Capital Securities Index(SM).. +10.8% +19.7%
BofA Merrill Lynch Adjustable Preferred Stock, 7% Constrained Index(SM)... +13.5% +16.3%
* The Bank of America Merrill Lynch 8% Capped DRD Preferred Stock Index(SM)
includes investment grade preferred securities issued by both corporations
and government agencies that qualify for the corporate dividends received
deduction with issuer concentration capped at a maximum of 8%. The Bank of
America Merrill Lynch 8% Capped Hybrid Preferred Securities Index(SM)
includes taxable, fixed-rate, U.S. dollar-denominated investment-grade,
preferred securities listed on a U.S. exchange with issuer concentration
capped at 8%. The Bank of America Merrill Lynch 8% Capped Corporate U.S.
Capital Securities Index(SM) includes investment grade fixed rate or
fixed-to-floating rate $1,000 par securities that receive some degree of
equity credit from the rating agencies or their regulators with issuer
concentration capped at a maximum of 8%. The Bank of America Merrill Lynch
Adjustable Preferred Stock, 7% Constrained Index(SM) includes adjustable
rate preferred securities issued by U.S. corporations and government
agencies with issuer concentration capped at a maximum of 7%. All index
returns include interest and dividend income, and, unlike the Fund's
returns, are unmanaged and do not reflect any expenses.
3
As shown in the first table, the Fund's performance demonstrates how
leverage again benefited common stock shareholders over the past
year--increasing current income and magnifying the positive returns over the
Fund's fiscal 2010. Although leverage can adversely impact Fund results in
unfavorable market environments, during the recent fiscal year leverage assisted
the Fund's NAV in significantly outperforming returns available in the preferred
securities market, as measured by the various BofA Merrill preferred indices.
TOTAL RETURN ON MARKET PRICE OF FUND SHARES
While our focus is primarily on managing the Fund's investment portfolio,
an investor's actual return is comprised of monthly dividend payments plus
changes in the Fund's MARKET PRICE. During the twelve months ending November 30,
2010, the total return on market price of Fund shares was +44.5%.
FLAHERTY & CRUMRINE PREFERRED INCOME OPPORTUNITY FUND (PFO)
PREMIUM/DISCOUNT OF MARKET PRICE TO NAV THROUGH 12/31/2010
(PERFORMANCE GRAPH)
2/21/92 0.0726
2/28/92 0.0805
3/6/92 0.0874
3/13/92 0.098
3/20/92 0.0819
3/27/92 0.0556
4/3/92 0.0538
4/10/92 0.0705
4/17/92 0.0547
4/24/92 0.059
5/1/92 0.0546
5/8/92 0.0536
5/15/92 0.0306
5/22/92 0.0248
5/29/92 0.0307
6/5/92 0.0181
6/12/92 0.04
6/19/92 0.0357
6/26/92 0.0442
7/3/92 0.0475
7/10/92 0.0626
7/17/92 0.08
7/24/92 0.0592
7/31/92 0.0647
8/7/92 0.0613
8/14/92 0.0628
8/21/92 0.0514
8/28/92 0.0539
9/4/92 0.0409
9/11/92 0.0684
9/18/92 0.0572
9/25/92 0.0539
10/2/92 0.062
10/9/92 0.0675
10/16/92 0.049
10/23/92 0.0188
10/30/92 0.0474
11/6/92 0.018
11/13/92 0.0188
11/20/92 0.0408
11/27/92 0.0844
12/4/92 0.063
12/11/92 0.0515
12/18/92 0.0691
12/25/92 0.0638
1/1/93 0.0621
1/8/93 0.0679
1/15/93 0.0595
1/22/93 0.0434
1/29/93 0.0475
2/5/93 0.0483
2/12/93 0.0284
2/19/93 0.0202
2/26/93 0.031
3/5/93 0.0473
3/12/93 0.0651
3/19/93 0.0303
3/26/93 0.036
4/2/93 0.0514
4/9/93 0.0675
4/16/93 0.057
4/23/93 0.0853
4/30/93 0.0651
5/7/93 0.0513
5/14/93 0.061
5/21/93 0.057
5/28/93 0.0441
6/4/93 0.0497
6/11/93 0.0561
6/18/93 0.0497
6/25/93 0.0417
7/2/93 0.0472
7/9/93 0.0425
7/16/93 0.0362
7/23/93 0.0068
7/30/93 0.0306
8/6/93 0.0212
8/13/93 0.0181
8/20/93 0.0008
8/27/93 0.037
9/3/93 0.0331
9/10/93 0.0401
9/17/93 0.0338
9/24/93 0.0244
10/1/93 0.0214
10/8/93 0.0261
10/15/93 0.0263
10/22/93 0.0246
10/29/93 0.009
11/5/93 0
11/12/93 -0.0107
11/19/93 -0.0282
11/26/93 -0.0179
12/3/93 -0.0076
12/10/93 -0.0334
12/17/93 -0.0338
12/24/93 -0.0431
12/31/93 0.0249
1/7/94 -0.0036
1/14/94 0.0157
1/21/94 -0.023
1/28/94 -0.0377
2/4/94 -0.0323
2/11/94 -0.0361
2/18/94 -0.0863
2/25/94 -0.05
3/4/94 -0.0392
3/11/94 -0.0315
3/18/94 -0.0585
3/25/94 -0.0562
4/1/94 -0.0556
4/8/94 -0.0612
4/15/94 -0.0771
4/22/94 -0.1012
4/29/94 -0.1145
5/6/94 -0.0775
5/13/94 -0.0633
5/20/94 -0.0636
5/27/94 -0.0312
6/3/94 -0.0683
6/10/94 -0.0288
6/17/94 -0.0457
6/24/94 -0.0393
7/1/94 -0.0409
7/8/94 -0.045
7/15/94 -0.049
7/22/94 -0.0294
7/29/94 -0.0327
8/5/94 -0.0221
8/12/94 -0.0303
8/19/94 -0.0269
8/26/94 -0.0348
9/2/94 -0.0204
9/9/94 -0.0318
9/16/94 -0.0409
9/23/94 -0.0628
9/30/94 -0.062
10/7/94 -0.1322
10/14/94 -0.1149
10/21/94 -0.141
10/28/94 -0.104
11/4/94 -0.0786
11/11/94 -0.0976
11/18/94 -0.099
11/25/94 -0.077
12/2/94 -0.0402
12/9/94 -0.0868
12/16/94 -0.0732
12/23/94 -0.0604
12/30/94 -0.0851
1/6/95 -0.001
1/13/95 -0.0141
1/20/95 -0.0303
1/27/95 -0.0619
2/3/95 -0.0119
2/10/95 -0.0314
2/17/95 -0.0702
2/24/95 -0.0376
3/3/95 -0.0297
3/10/95 -0.0585
3/17/95 -0.0523
3/24/95 -0.0534
3/31/95 -0.0393
4/7/95 -0.0341
4/14/95 -0.0393
4/21/95 -0.069
4/28/95 -0.0341
5/5/95 -0.0576
5/12/95 -0.0501
5/19/95 -0.0933
5/26/95 -0.0753
6/2/95 -0.0481
6/9/95 -0.0729
6/16/95 -0.0702
6/23/95 -0.0749
6/30/95 -0.0686
7/7/95 -0.069
7/14/95 -0.0869
7/21/95 -0.1087
7/28/95 -0.0911
8/4/95 -0.0973
8/11/95 -0.1018
8/18/95 -0.1011
8/25/95 -0.078
9/1/95 -0.0706
9/8/95 -0.0833
9/15/95 -0.071
9/22/95 -0.0749
9/29/95 -0.0641
10/6/95 -0.0718
10/13/95 -0.1006
10/20/95 -0.0909
10/27/95 -0.1012
11/3/95 -0.1232
11/10/95 -0.0962
11/17/95 -0.1071
11/24/95 -0.1093
12/1/95 -0.1014
12/8/95 -0.1277
12/15/95 -0.1233
12/22/95 -0.1265
12/29/95 -0.1454
1/5/96 -0.1197
1/12/96 -0.1279
1/19/96 -0.1312
1/26/96 -0.1146
2/2/96 -0.1233
2/9/96 -0.1233
2/16/96 -0.1279
2/23/96 -0.1303
3/1/96 -0.1124
3/8/96 -0.1465
3/15/96 -0.1508
3/22/96 -0.1487
3/29/96 -0.1515
4/5/96 -0.1315
4/12/96 -0.1286
4/19/96 -0.1279
4/26/96 -0.1383
5/3/96 -0.1257
5/10/96 -0.113
5/17/96 -0.1408
5/24/96 -0.1386
5/31/96 -0.1386
6/7/96 -0.1255
6/14/96 -0.1337
6/21/96 -0.1301
6/28/96 -0.0918
7/5/96 -0.1079
7/12/96 -0.0911
7/19/96 -0.1122
7/26/96 -0.0939
8/2/96 -0.0876
8/9/96 -0.0688
8/16/96 -0.0673
8/23/96 -0.0881
8/30/96 -0.0836
9/6/96 -0.0836
9/13/96 -0.0661
9/20/96 -0.0889
9/27/96 -0.0991
10/4/96 -0.0876
10/11/96 -0.0876
10/18/96 -0.0935
10/25/96 -0.0834
11/1/96 -0.0796
11/8/96 -0.0932
11/15/96 -0.0726
11/22/96 -0.0586
11/29/96 -0.0608
12/6/96 -0.0792
12/13/96 -0.0813
12/20/96 -0.1009
12/27/96 -0.0837
1/3/97 -0.0693
1/10/97 -0.0562
1/17/97 -0.0693
1/24/97 -0.0834
1/31/97 -0.0678
2/7/97 -0.0623
2/14/97 -0.0551
2/21/97 -0.0645
2/28/97 -0.0605
3/7/97 -0.0581
3/14/97 -0.0654
3/21/97 -0.0715
3/28/97 -0.0715
4/4/97 -0.0573
4/11/97 -0.0973
4/18/97 -0.0806
4/25/97 -0.0748
5/2/97 -0.0672
5/9/97 -0.052
5/16/97 -0.0647
5/23/97 -0.0573
5/30/97 -0.0362
6/6/97 -0.0615
6/13/97 -0.0385
6/20/97 -0.0473
6/27/97 -0.0418
7/4/97 -0.0498
7/11/97 -0.0585
7/18/97 -0.0486
7/25/97 -0.063
8/1/97 -0.0273
8/8/97 -0.0701
8/15/97 -0.0715
8/22/97 -0.0767
8/29/97 -0.0472
9/5/97 -0.058
9/12/97 -0.0656
9/19/97 -0.0557
9/26/97 -0.0492
10/3/97 -0.0292
10/10/97 -0.0492
10/17/97 -0.0506
10/24/97 -0.0574
10/31/97 -0.0477
11/7/97 -0.0442
11/14/97 -0.0377
11/21/97 -0.0688
11/28/97 -0.0484
12/5/97 -0.0406
12/12/97 -0.0652
12/19/97 -0.0648
12/26/97 -0.0456
1/2/98 -0.0171
1/9/98 -0.0197
1/16/98 -0.0185
1/23/98 -0.062
1/30/98 -0.0477
2/6/98 -0.053
2/13/98 -0.0604
2/20/98 -0.0456
2/27/98 -0.0477
3/6/98 -0.0473
3/13/98 -0.0568
3/20/98 -0.0487
3/27/98 -0.0579
4/3/98 -0.0682
4/10/98 -0.0508
4/17/98 -0.062
4/24/98 -0.0768
5/1/98 -0.0618
5/8/98 -0.054
5/15/98 -0.0717
5/22/98 -0.0664
5/29/98 -0.0648
6/5/98 -0.0643
6/12/98 -0.0627
6/19/98 -0.0573
6/26/98 -0.06
7/3/98 -0.0575
7/10/98 -0.0562
7/17/98 -0.0563
7/24/98 -0.0465
7/31/98 -0.0526
8/7/98 -0.0472
8/14/98 -0.0864
8/21/98 -0.0954
8/28/98 -0.054
9/4/98 -0.0618
9/11/98 -0.0487
9/18/98 -0.0392
9/25/98 -0.0402
10/2/98 -0.0554
10/9/98 -0.0744
10/16/98 -0.0485
10/23/98 -0.0406
10/30/98 -0.0616
11/6/98 -0.0396
11/13/98 -0.0481
11/20/98 -0.0641
11/27/98 -0.0478
12/4/98 -0.0413
12/11/98 -0.0363
12/18/98 -0.0537
12/25/98 -0.0132
1/1/99 -0.0196
1/8/99 -0.0297
1/15/99 -0.0392
1/22/99 -0.0627
1/29/99 -0.0677
2/5/99 -0.061
2/12/99 -0.0887
2/19/99 -0.0937
2/26/99 -0.1078
3/5/99 -0.0846
3/12/99 -0.065
3/19/99 -0.1022
3/26/99 -0.0888
4/2/99 -0.0724
4/9/99 -0.1029
4/16/99 -0.0781
4/23/99 -0.093
4/30/99 -0.1156
5/7/99 -0.1015
5/14/99 -0.1277
5/21/99 -0.1256
5/28/99 -0.1093
6/4/99 -0.1007
6/11/99 -0.0558
6/18/99 -0.0835
6/25/99 -0.0602
7/2/99 -0.0532
7/9/99 -0.0532
7/16/99 -0.0761
7/23/99 -0.0558
7/30/99 -0.0829
8/6/99 -0.0464
8/13/99 -0.078
8/20/99 -0.0864
8/27/99 -0.0345
9/3/99 -0.1057
9/10/99 -0.0938
9/17/99 -0.0683
9/24/99 -0.0401
10/1/99 -0.077
10/8/99 -0.086
10/15/99 -0.1231
10/22/99 -0.1254
10/29/99 -0.1223
11/5/99 -0.1192
11/12/99 -0.1252
11/19/99 -0.0826
11/26/99 -0.0979
12/3/99 -0.097
12/10/99 -0.0807
12/17/99 -0.1118
12/24/99 -0.1212
12/31/99 -0.0354
1/7/00 -0.0028
1/14/00 -0.0385
1/21/00 -0.0996
1/28/00 -0.1047
2/4/00 -0.0923
2/11/00 -0.0845
2/18/00 -0.1038
2/25/00 -0.0962
3/3/00 -0.1021
3/10/00 -0.0858
3/17/00 -0.1055
3/24/00 -0.1272
3/31/00 -0.1361
4/7/00 -0.1047
4/14/00 -0.0894
4/21/00 -0.0781
4/28/00 -0.064
5/5/00 -0.0385
5/12/00 -0.0566
5/19/00 -0.0734
5/26/00 -0.0759
6/2/00 -0.0905
6/9/00 -0.1037
6/16/00 -0.0943
6/23/00 -0.0775
6/30/00 -0.0841
7/7/00 -0.0909
7/14/00 -0.0893
7/21/00 -0.097
7/28/00 -0.0927
8/4/00 -0.0912
8/11/00 -0.0879
8/18/00 -0.1046
8/25/00 -0.1046
9/1/00 -0.1105
9/8/00 -0.1113
9/15/00 -0.0836
9/22/00 -0.1189
9/29/00 -0.1155
10/6/00 -0.0896
10/13/00 -0.0921
10/20/00 -0.0895
10/27/00 -0.0725
11/3/00 -0.0739
11/10/00 -0.0747
11/17/00 -0.0962
11/24/00 -0.0937
12/1/00 -0.0928
12/8/00 -0.0903
12/15/00 -0.0913
12/22/00 -0.0672
12/29/00 -0.0276
1/5/01 -0.0411
1/12/01 -0.02
1/19/01 -0.0077
1/26/01 0.0192
2/2/01 -0.0528
2/9/01 -0.0346
2/16/01 -0.0184
2/23/01 -0.0257
3/2/01 -0.0109
3/9/01 -0.036
3/16/01 -0.0393
3/23/01 -0.036
3/30/01 -0.0109
4/6/01 0.02
4/13/01 0.0046
4/20/01 0.0243
4/27/01 -0.0278
5/4/01 -0.0218
5/11/01 0.0037
5/18/01 -0.0228
5/25/01 -0.0111
6/1/01 -0.0345
6/8/01 -0.0325
6/15/01 -0.0654
6/22/01 -0.0623
6/29/01 -0.0379
7/6/01 -0.0307
7/13/01 -0.0098
7/20/01 -0.0264
7/27/01 0.0237
8/3/01 0.0035
8/10/01 -0.0567
8/17/01 -0.0439
8/24/01 -0.0365
8/31/01 -0.0603
9/7/01 -0.0353
9/14/01 -0.0353
9/21/01 0
9/28/01 -0.0414
10/5/01 -0.0433
10/12/01 -0.0114
10/19/01 -0.0191
10/26/01 -0.0138
11/2/01 0.0017
11/9/01 -0.0068
11/16/01 0.026
11/23/01 0.0304
11/30/01 -0.0284
12/7/01 -0.0009
12/14/01 -0.0201
12/21/01 0.021
12/28/01 0.0289
1/4/02 0.0297
1/11/02 0.0276
1/18/02 0.0268
1/25/02 0.0677
2/1/02 0.0444
2/8/02 0.0607
2/15/02 0.0457
2/22/02 0.0582
3/1/02 0.0595
3/8/02 0.0124
3/15/02 0.0302
3/22/02 0.0383
3/29/02 0.04
4/5/02 0.0248
4/12/02 0.0409
4/19/02 0.0394
4/26/02 0.0526
5/3/02 0.0839
5/10/02 0.0595
5/17/02 0.0858
5/24/02 0.0757
5/31/02 0.0766
6/7/02 0.0832
6/14/02 0.067
6/21/02 0.0743
6/28/02 0.0933
7/5/02 0.1238
7/12/02 0.0692
7/19/02 0.0972
7/26/02 0.1421
8/2/02 0.1372
8/9/02 0.1002
8/16/02 0.1195
8/23/02 0.1206
8/30/02 0.1077
9/6/02 0.1002
9/13/02 0.0965
9/20/02 0.0993
9/27/02 0.1042
10/4/02 0.1141
10/11/02 0.1429
10/18/02 0.0519
10/25/02 0.0741
11/1/02 0.0733
11/8/02 0.0721
11/15/02 0.0664
11/22/02 0.061
11/29/02 0.0872
12/6/02 0.0972
12/13/02 0.1086
12/20/02 0.1278
12/27/02 0.1558
1/3/03 0.1518
1/10/03 0.093
1/17/03 0.1092
1/24/03 0.0865
1/31/03 0.1038
2/7/03 0.0983
2/14/03 0.096
2/21/03 0.1148
2/28/03 0.0969
3/7/03 0.1258
3/14/03 0.1585
3/21/03 0.0897
3/28/03 0.1033
4/4/03 0.1225
4/11/03 0.1477
4/18/03 0.1463
4/25/03 0.1211
5/2/03 0.0989
5/9/03 0.0553
5/16/03 0.033
5/23/03 0.0145
5/30/03 0.0486
6/6/03 -0.0024
6/13/03 -0.0086
6/20/03 0.0032
6/27/03 0.0144
7/4/03 0.0296
7/11/03 -0.0249
7/18/03 -0.0105
7/25/03 -0.0049
8/1/03 -0.0353
8/8/03 -0.0217
8/15/03 -0.0297
8/22/03 0.0008
8/29/03 -0.0032
9/5/03 0.0008
9/12/03 -0.0112
9/19/03 -0.023
9/26/03 -0.0346
10/3/03 -0.0214
10/10/03 -0.0207
10/17/03 -0.0254
10/24/03 0.0095
10/31/03 0.0284
11/7/03 0.0422
11/14/03 0.0386
11/21/03 0.074
11/28/03 0.0731
12/5/03 0.0875
12/12/03 0.0816
12/19/03 0.1044
12/26/03 0.1084
1/2/04 0.129
1/9/04 0.1265
1/16/04 0.1176
1/23/04 0.1305
1/30/04 0.1482
2/6/04 0.1425
2/13/04 0.1404
2/20/04 0.1598
2/27/04 0.1199
3/5/04 0.125
3/12/04 0.1358
3/19/04 0.1518
3/26/04 0.1631
4/2/04 0.1128
4/9/04 0.0576
4/16/04 0.0812
4/23/04 0.0174
4/30/04 0.0229
5/7/04 0.0056
5/14/04 0.0535
5/21/04 0.0802
5/28/04 0.0808
6/4/04 0.0662
6/11/04 0.0541
6/18/04 0.0466
6/25/04 0.0503
7/2/04 0.0502
7/9/04 0.0535
7/16/04 0.0572
7/23/04 0.0604
7/30/04 0.0471
8/6/04 0.0884
8/13/04 0.0798
8/20/04 0.0958
8/27/04 0.1202
9/3/04 0.1234
9/10/04 0.1265
9/17/04 0.1212
9/24/04 0.0843
10/1/04 0.0966
10/8/04 0.0858
10/15/04 0.0957
10/22/04 0.0944
10/29/04 0.0865
11/5/04 0.1136
11/12/04 0.1112
11/19/04 0.113
11/26/04 0.1065
12/3/04 0.057
12/10/04 0.0445
12/17/04 0.0643
12/24/04 0.0955
12/31/04 0.0731
1/7/05 0.0837
1/14/05 0.0708
1/21/05 0.0705
1/28/05 0.0682
2/4/05 0.0635
2/11/05 0.0689
2/18/05 0.0876
2/25/05 0.0751
3/4/05 0.0467
3/11/05 0
3/18/05 -0.0252
3/25/05 -0.0463
4/1/05 -0.0268
4/8/05 -0.0182
4/15/05 -0.0361
4/22/05 -0.0471
4/29/05 -0.0196
5/6/05 0.0016
5/13/05 -0.0047
5/20/05 0.0213
5/27/05 0.0205
6/3/05 0.0242
6/10/05 0.0259
6/17/05 -0.0316
6/24/05 0.0024
7/1/05 0.0207
7/8/05 0.0345
7/15/05 0.0619
7/22/05 0.0492
7/29/05 0.0668
8/5/05 0.0743
8/12/05 0.0343
8/19/05 0.0621
8/26/05 0.0686
9/2/05 0.0745
9/9/05 0.0994
9/16/05 0.0914
9/23/05 0.0543
9/30/05 0.0546
10/7/05 0.0204
10/14/05 -0.0057
10/21/05 -0.0164
10/28/05 -0.0372
11/4/05 -0.0431
11/11/05 -0.0361
11/18/05 -0.0221
11/25/05 -0.0305
12/2/05 -0.0231
12/9/05 -0.0561
12/16/05 -0.0796
12/23/05 -0.0735
12/30/05 -0.094
1/6/06 -0.0457
1/13/06 0.0178
1/20/06 0.0334
1/27/06 0.027
2/3/06 0.03
2/10/06 0.0137
2/17/06 0.0146
2/24/06 0.0146
3/3/06 0.0195
3/10/06 -0.0624
3/17/06 -0.0453
3/24/06 -0.0593
3/31/06 -0.0645
4/7/06 -0.0606
4/14/06 -0.0842
4/21/06 -0.0798
4/28/06 -0.0735
5/5/06 -0.0842
5/12/06 -0.096
5/19/06 -0.1087
5/26/06 -0.0865
6/2/06 -0.0796
6/9/06 -0.0954
6/16/06 -0.0938
6/23/06 -0.0785
6/30/06 -0.0641
7/7/06 -0.0782
7/14/06 -0.0584
7/21/06 -0.0477
7/28/06 -0.0444
8/4/06 -0.0025
8/11/06 0.0252
8/18/06 -0.0248
8/25/06 -0.0249
9/1/06 -0.0099
9/8/06 -0.0206
9/15/06 -0.0173
9/22/06 -0.0252
9/29/06 -0.0358
10/6/06 -0.009
10/13/06 -0.0164
10/20/06 -0.0254
10/27/06 -0.0307
11/3/06 -0.0243
11/10/06 -0.0401
11/17/06 -0.004
11/24/06 -0.0064
12/1/06 -0.0166
12/8/06 0.0008
12/15/06 0.004
12/22/06 -0.0202
12/29/06 -0.0024
1/5/07 -0.0024
1/12/07 0.0045
1/19/07 0.0088
1/26/07 0.0081
2/2/07 -0.0032
2/9/07 0.0081
2/16/07 -0.0048
2/23/07 -0.0056
3/2/07 -0.0063
3/9/07 0.0064
3/16/07 -0.0048
3/23/07 0.0089
3/30/07 0.0276
4/5/07 0.0366
4/13/07 0.0147
4/20/07 0.0024
4/27/07 0.0368
5/4/07 0.0235
5/11/07 0.0089
5/18/07 0.0164
5/25/07 0.0157
6/1/07 0.0075
6/8/07 -0.02
6/15/07 -0.0242
6/22/07 -0.025
6/29/07 0.0025
7/6/07 -0.0302
7/13/07 -0.0436
7/20/07 -0.0093
7/27/07 -0.0139
8/3/07 -0.0131
8/10/07 -0.0203
8/17/07 -0.1041
8/24/07 -0.0385
8/31/07 -0.0214
9/7/07 -0.0416
9/14/07 -0.0335
9/21/07 -0.0009
9/28/07 0.0115
10/5/07 0.0098
10/12/07 -0.0168
10/19/07 -0.0605
10/26/07 -0.008
11/2/07 -0.0398
11/9/07 -0.0483
11/16/07 -0.0145
11/23/07 0.017
11/30/07 0.0158
12/7/07 -0.011
12/14/07 -0.0435
12/21/07 -0.0356
12/28/07 -0.0031
1/4/08 0.0161
1/11/08 0.0098
1/18/08 0.0542
1/25/08 0.0797
2/1/08 0.0601
2/8/08 0.0797
2/15/08 0.0191
2/22/08 0.0519
2/29/08 0.0121
3/7/08 0.0215
3/14/08 -0.0022
3/20/08 0.0481
3/28/08 0.0348
4/4/08 0.0327
4/11/08 -0.0045
4/18/08 0.0089
4/25/08 0.0608
5/2/08 0.0686
5/9/08 0.0766
5/16/08 0.0837
5/23/08 0.1357
5/30/08 0.125
6/6/08 0.1172
6/13/08 0.115
6/20/08 0.1076
6/27/08 0.162
6/30/08 0.1481
7/3/08 0.1314
7/11/08 0.156
7/18/08 0.1586
7/25/08 0.0288
8/1/08 0.0648
8/8/08 0.0618
8/15/08 0.0334
8/22/08 0.0249
8/29/08 -0.0149
9/5/08 -0.0392
9/12/08 -0.0373
9/19/08 -0.03
9/26/08 -0.0378
10/3/08 -0.2004
10/10/08 -0.4599
10/17/08 -0.1616
10/24/08 -0.1902
10/31/08 -0.0623
11/7/08 -0.1202
11/14/08 -0.2292
11/21/08 -0.4009
11/28/08 -0.1656
12/5/08 -0.2561
12/12/08 -0.2839
12/19/08 -0.1375
12/26/08 -0.1446
12/31/08 -0.1051
1/2/09 -0.0367
1/9/09 -0.0391
1/16/09 -0.0882
1/23/09 -0.0705
1/30/09 -0.0423
2/6/09 0.0106
2/13/09 0.1285
2/20/09 0.0656
2/27/09 0.0638
3/6/09 -0.1859
3/13/09 -0.0203
3/20/09 -0.0437
3/27/09 0.0401
3/31/09 0.0302
4/3/09 0.078
4/9/09 0.0576
4/17/09 0.0959
4/24/09 0.0917
5/1/09 0.0899
5/8/09 0.0359
5/15/09 0.0484
5/22/09 0.1534
5/29/09 0.0559
6/5/09 0.0717
6/12/09 0.0792
6/19/09 0.0233
6/26/09 0.0341
6/30/09 0.031
7/2/09 0.0146
7/10/09 0
7/17/09 0.1093
7/24/09 0.0339
7/31/09 -0.0122
8/7/09 -0.0339
8/14/09 -0.0404
8/21/09 -0.0147
8/28/09 -0.043
8/31/09 -0.0486
9/4/09 -0.0231
9/11/09 -0.0572
9/18/09 -0.0163
9/25/09 -0.0265
9/30/09 -0.0371
10/2/09 -0.0423
10/9/09 -0.0341
10/16/09 -0.0374
10/23/09 -0.0633
10/30/09 -0.1
11/6/09 -0.0957
11/13/09 -0.0859
11/20/09 -0.0806
11/27/09 -0.0752
11/30/09 -0.0677
12/4/09 -0.0849
12/11/09 -0.0667
12/18/09 0.0267
12/24/09 0.0473
12/31/09 -0.0143
1/8/10 -0.0152
1/15/10 -0.0149
1/22/10 -0.0116
1/29/10 -0.028
2/5/10 -0.0574
2/12/10 0.0047
2/19/10 0.0433
2/26/10 0.0207
3/5/10 0.0011
3/12/10 -0.0203
3/19/10 0.1079
3/26/10 0.1034
3/31/10 0.0982
4/1/10 0.1012
4/9/10 0.0949
4/16/10 0.0809
4/23/10 0.0982
4/30/10 0.1033
5/7/10 0.0658
5/14/10 0.1674
5/21/10 0.0804
5/28/10 0.1176
6/4/10 0.1148
6/11/10 0.1458
6/18/10 0.103
6/25/10 0.0862
6/30/10 0.0806
7/2/10 0.0588
7/9/10 0.065
7/16/10 0.0413
7/23/10 0.0945
7/30/10 0.0934
8/6/10 0.1115
8/13/10 0.1066
8/20/10 0.1146
8/27/10 0.0781
8/31/10 0.0876
9/3/10 0.0864
9/10/10 0.1247
9/17/10 0.119
9/24/10 0.0647
9/30/10 0.1058
10/8/10 0.08
10/15/10 0.0899
10/22/10 0.032
10/29/10 0.0387
11/5/10 0.0416
11/12/10 0.0335
11/19/10 -0.0133
11/26/10 0.0216
11/30/10 0.0164
12/3/10 0.0041
12/10/10 -0.0238
12/17/10 -0.0176
12/23/10 -0.0105
12/31/10 -0.0176
In a perfect world, the market price of Fund shares would closely track the
Fund's net asset value. As can be seen from the graph above, this often is not
the case. For most of the past year the market price has been above the NAV (in
market parlance, "trading at a premium"). Because the Fund began fiscal 2010
with its market price below NAV ("trading at a discount") and ended the fiscal
year above, the total return earned on market price exceeded the total return on
NAV.
Based on a closing price of $9.48 on December 31st, the current annualized
yield on the market price of the Fund's shares (assuming the current monthly
distribution of $0.0735 does not change) is 9.30%. In our opinion, this
distribution rate measures up favorably with most comparable investment
opportunities.
PREFERRED MARKET CONDITIONS
By most measures, preferred market trading conditions are back to
pre-crisis levels. Trading volumes and bid/offer spreads, though never robust
compared to other major market segments, have returned to more customary levels.
In our opinion, preferred securities remain attractively valued relative to
other fixed income securities; plus, we are still finding opportunities to add
value through credit research and security selection.
4
Credit conditions continue to improve. The economy is growing fast enough
for profits to rebound nicely, but not fast enough to generate much demand for
new capital spending by corporations. Households are paying down debt, driving
investors who had previously purchased mortgage and credit card debt into other
asset classes. Corporations are showing strong cash flow, improved interest
coverage, and growing liquidity. Loan quality is improving, with delinquencies
and charge-offs falling in almost all loan categories--though commercial real
estate remains an important exception. Overall, credit default rates continue to
trend lower. The result is good demand for preferred securities, little new
issuance, and tighter spreads. We think these factors will continue to benefit
the markets for some time to come.
Trading activity in the "retail" segment of the market(2) has been boosted
by the rapid growth of exchange traded funds. ETF's that invest primarily in
preferred securities are "rules based" in that there is limited discretion
about how a fund is managed--the objective is to closely track a specific index.
We sometimes scratch our heads as to the appeal of these funds, but they do
provide a healthy dose of liquidity, and they have attracted a lot of new
investors to the preferred market.
In the aftermath of the financial crisis, new legislation (much of which
has yet to be implemented) has resulted in wide ranging changes to the banking
industry. Since preferred securities issued by banks comprise over sixty
percent of the overall market, we watch this legislation with great interest. In
the topic which follows, we discuss the most relevant regulatory changes; here,
we'll focus on market impact.
One thing we know for sure--certain types of preferred securities will
eventually become obsolete. It is now clear that regulatory changes will
diminish the benefits of some securities to the banks that issued them, and as a
result, it is widely assumed many preferred securities will be retired at the
earliest practical opportunity. The prospects of issuer redemptions have
provided a boost to the market.
Of course, this wouldn't be the preferred market without a fair share of
hazards. In some cases, buried deep in the documentation of a security, there is
language which permits the issuer to exercise an early redemption, at par, if
certain events occur. Without such a provision, the issuer would either have to
pay a premium to call the issue, or may not be permitted to call it at all until
some future date. Such events, which seemed remote just a couple years ago, have
in fact occurred in response to changes in financial regulation.
Market participants appear to have adjusted expectations about early
redemption of NON-BANK preferred securities as well, though for different
reasons. Recall that companies choose to issue preferred securities in part
because it can improve the ratings on its debt, which in turn can reduce the
all-in cost of its capital (since preferred is ranked "junior" to debt, the debt
is viewed to be more secure). The major rating agencies have become less
inclined to look favorably on certain types of preferred securities, hence
non-bank issuers may also be inclined to retire certain preferred issues sooner
than expected. The redemption terms of these non-bank issues haven't changed,
but the market now perceives the likelihood of issuer redemption to be higher
and as a result, prices adjust to reflect the perception.
While it has become clear that certain types of preferred securities are
destined to become a footnote in financial textbooks, a viable replacement has
yet to emerge. A lot of smart people are hard at work to build a better
preferred, and we're optimistic they will succeed (though it may take a few
iterations). You can bet we will be involved!
----------
(2) In general, rules for ETF's that invest primarily in preferred securities
require the funds to invest only in securities listed on a national stock
exchange; such issues comprise roughly half of the preferred market.
5
All of this leads to one unavoidable conclusion: DURING THE NEXT FEW YEARS,
MARKET PARTICIPANTS, INCLUDING THE FUND, WILL NEED TO FIND REPLACEMENTS FOR A
SIGNIFICANT NUMBER OF HIGH YIELDING SECURITIES. At this juncture, of course, we
cannot tell how the Fund will weather this reinvestment risk.
UPDATE ON REGULATORY AND CAPITAL REFORM FOR BANKS
As we discussed in detail in the Fund's semiannual report from May 2010,
banks face significant new regulation and stiffer capital requirements. We will
quickly summarize the key features of bank regulatory reform from the Dodd-Frank
bill and bank capital requirements from the Basel Committee on Bank
Supervision--both from the perspective of preferred investors.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank)
makes significant changes to banks' operations and capital requirements. Most
importantly for preferred investors, it eliminates trust preferred securities
(TruPS) from Tier 1 capital for most banks the Funds would invest in. (Tier 1
capital is one of the primary measures of capital for a financial company; it
includes common equity, retained earnings, qualifying preferred capital, and
regulatory assets). The new rules phase in starting from 2013 through 2015. This
change in regulatory treatment for TruPS makes it likely that most, though not
all, TruPS will be called between 2013 and 2016, as banks replace those
instruments with qualifying forms of Tier 1 capital. As of this writing,
roughly 23% of the Fund's portfolio is invested in trust preferred securities
issued by U.S. banks.
Along with changes made by lawmakers in the U.S., the Basel Committee on
Banking Supervision in recent months has released its Basel III framework on
bank capital. (This committee sets international banking standards that are
subsequently adopted by national regulators, including the U.S.). These new
rules will sharply increase the amount of common equity capital held by banks,
while leaving an important role for preferred securities.
Currently, banks must hold at least 2.5% of risk-weighted assets (RWA) in
the form of common equity. (The U.S. minimum is 4% common equity, and most banks
carry substantially more than the minimum.) When Basel III is fully phased in,
minimum common equity will rise to 4.5% of RWA. Coupled with some additionally
required "capital buffers," we suspect that U.S. banks typically will hold 8-10%
common equity and at least 10-12% Tier 1 capital, two to four percentage points
higher than before the financial crisis. That's a lot more common equity
providing credit support to preferred securities, which will comprise much of
the difference between total Tier 1 and Tier 1 common equity.
Another likely, but still undecided, feature of the Basel III rules is a
provision to impose "loss absorbency" on any non-common Tier 1 capital
instruments. The theory is that all Tier 1 capital should be able to absorb
losses on both a "gone concern" basis (i.e., in bankruptcy or receivership) AND
on a "going-concern" basis. Historically, preferred securities have provided
substantial loss absorbency upon failure of a firm, since all preferred claims
are subordinate to claims of depositors and senior creditors. However,
preferreds are-- strictly by their contractual terms--only moderately loss
absorbing on a going concern basis, because the issuer can defer dividend
payments but not eliminate the preferred liability outright in times of strain.
The Basel Committee wants to give regulators the ability to either convert
preferreds to common stock or write off the preferred liability if they believe
the bank is no longer viable.
We have written a lengthy comment letter to the Basel Committee on loss
absorbency. Interested readers will find it on the Fund's website or at the
Basel Committee website at http://www.bis.org/publ/bcbs174/fac.pdf. Suffice to
say that we think the proposed loss absorption provision for bank preferreds is
unnecessary in the United States, and perhaps elsewhere. Nonetheless, if
regulators insist on it, we think a properly designed
6
mechanism to convert preferred into common stock would be acceptable to
preferred investors, while a write-off mechanism would not. We await the
Committee's decision on this sometime in 2011.
Overall, the new regulatory framework being imposed on banks by Dodd-Frank
and Basel III will force banks to hold more capital or take less risk, or both.
With respect to bank capital, regulators are requiring substantially more common
equity capital than before, while retaining a meaningful role for preferred
securities. These developments are broadly supportive for bank preferreds,
though they do increase regulatory risk. As the new rules get implemented over
the next several years, there will be numerous changes and opportunities
awaiting preferred investors.
THE FUND'S LEVERAGE
Leverage is an important part of the Fund's strategy to produce high
current income. Over time, the cost of leverage is typically lower than the
yield on the Fund's portfolio. The difference between what the Fund earns on its
investments and pays on the money it borrows increases the income available to
common share-holders. Over the past fiscal year, the Fund has paid an average
interest rate of 1.443% on its borrowed money. Given the much higher current
yields generated by the Fund's portfolio, this use of leverage had a meaningful
positive impact on the Fund's dividends to common shareholders.
In addition to economic considerations, there is a set of rules that govern
leverage (most importantly, the terms and conditions of the Fund's leverage
agreement with its lender, and all relevant securities laws). We take all of
these factors into consideration as we manage the leverage AND the assets of the
Fund.
There are two useful measures of how much leverage the Fund has in place.
The first is simply the total dollar amount of leverage. The other measure is
the ratio of the Fund's assets financed by that leverage (in other words, the
amount of leverage divided by total assets). The chart below presents both
measures of leverage over the past three years.
PFO LEVERAGE HISTORY
(PERFORMANCE GRAPH)
PFO LEVERAGE
DATE PERCENT
---------- --------
12/28/2007 38.3%
1/25/2008 37.2%
2/29/2008 37.4%
3/28/2008 40.8%
4/25/2008 40.5%
5/30/2008 40.3%
6/27/2008 42.1%
7/25/2008 44.8%
8/29/2008 44.6%
10/3/2008 51.9%
10/31/2008 48.6%
11/28/2008 47.1%
12/26/2008 46.1%
1/30/2009 45.8%
2/27/2009 42.2%
3/27/2009 42.1%
4/24/2009 40.2%
5/29/2009 35.0%
6/26/2009 33.4%
6/30/2009 33.5%
7/2/2009 33.3%
7/10/2009 33.1%
7/17/2009 33.4%
7/24/2009 33.1%
7/31/2009 31.9%
8/7/2009 31.2%
8/14/2009 30.7%
8/21/2009 31.1%
8/28/2009 30.6%
8/31/2009 30.5%
9/4/2009 33.3%
9/11/2009 32.8%
9/18/2009 33.3%
9/25/2009 33.3%
9/30/2009 33.3%
10/2/2009 33.2%
10/9/2009 33.1%
10/16/2009 32.7%
10/23/2009 33.3%
10/30/2009 33.3%
11/6/2009 33.5%
11/13/2009 33.3%
11/20/2009 33.2%
11/27/2009 33.1%
11/30/2009 33.1%
12/4/2009 33.0%
12/11/2009 32.8%
12/18/2009 32.4%
12/24/2009 32.4%
12/31/2009 32.0%
1/8/2010 31.6%
1/15/2010 31.2%
1/22/2010 31.5%
1/29/2010 31.6%
2/5/2010 33.3%
2/12/2010 33.4%
2/16/2010 33.4%
2/19/2010 33.4%
2/26/2010 33.1%
3/5/2010 32.8%
3/12/2010 33.3%
3/19/2010 33.3%
3/26/2010 33.1%
3/31/2010 32.9%
4/1/2010 32.8%
4/16/2010 33.3%
4/23/2010 33.3%
4/30/2010 33.5%
5/7/2010 34.4%
5/14/2010 34.2%
5/24/2010 35.1%
5/28/2010 35.0%
6/4/2010 34.9%
6/11/2010 34.9%
6/18/2010 34.6%
6/25/2010 34.7%
6/30/2010 34.7%
7/2/2010 34.7%
7/9/2010 34.5%
7/16/2010 34.1%
7/23/2010 34.0%
7/30/2010 33.7%
8/6/2010 33.3%
8/13/2010 33.2%
8/20/2010 33.1%
8/27/2010 33.1%
8/31/2010 33.0%
9/3/2010 32.9%
9/10/2010 32.8%
9/17/2010 32.5%
9/24/2010 32.5%
9/30/2010 32.3%
10/1/2010 32.3%
10/8/2010 32.1%
10/15/2010 32.2%
10/22/2010 32.2%
10/29/2010 31.9%
11/5/2010 31.9%
11/12/2010 31.9%
11/19/2010 32.0%
11/26/2010 32.1%
11/30/2010 32.1%
12/3/2010 32.2%
12/10/2010 32.2%
12/17/2010 33.3%
12/23/2010 33.7%
12/31/2010 33.4%
MONTH END MONEY MARKET LOAN AMOUNT
DATE PREFERRED STOCK DRAWN
---------- --------------- -----------
12/31/2007 70 0
1/31/2008 70 0
2/29/2008 70 0
3/31/2008 70 0
4/30/2008 70 0
5/31/2008 70 0
6/30/2008 70 0
7/31/2008 70 0
8/31/2008 70 0
9/30/2008 70 0
10/31/2008 58 0
11/30/2008 50 0
12/31/2008 50 0
1/31/2009 50 0
2/28/2009 37 0
3/31/2009 37 0
4/30/2009 37 0
5/31/2009 37 0
6/30/2009 37 0
7/31/2009 37 0
8/31/2009 0 37
9/30/2009 0 45
10/31/2009 0 47
11/30/2009 0 47
12/31/2009 0 47
1/31/2010 0 47
2/28/2010 0 51
3/31/2010 0 53
4/30/2010 0 55
5/31/2010 0 55
6/30/2010 0 55
7/31/2010 0 55
8/31/2010 0 55
9/30/2010 0 55
10/31/2010 0 55
11/30/2010 0 55
12/31/2010 0 58
7
When the leverage was comprised entirely of auction preferred stock, the
AMOUNT of leverage rarely changed. As a result, the PERCENTAGE of the Fund's
leverage to total net assets varied as the value the portfolio moved up or
down. As can be seen in the chart, the leverage percentage climbed steadily as
the financial crisis unfolded from 2007 through early 2009 and the value of the
Fund's investment portfolio fell.
As the leverage ratio rose to unsustainable levels, the Fund sold assets
and used the proceeds to reduce leverage. While this meant that monthly
distributions to shareholders had to be cut, it also served to reduce the NAV
and market price risk to the Fund's common shareholders.
With debt leverage, the Fund now has the ability to INCREASE the amount
borrowed by the Fund (within certain limits!). This is important because the
dramatic recovery in asset prices meant the Fund could comfortably borrow more
and use the money to purchase additional securities. Throughout 2010, the Fund
continued to increase its leverage balances. These increases, at very favorable
interest rates, allowed the Fund to increase its monthly dividend three times
since December 2009, for a total of 28% in cumulative increases.
The "right" percentage of leverage in a fund is never a simple matter to
determine. Type of borrowing, the cost of funds and market conditions all will
be factors to consider. At present, we are comfortable with the leverage
percentage used by the Fund, and we will consider increasing or decreasing the
amount of borrowing based on future market conditions. Of course, we
continuously monitor our leverage balances and try to use leverage in a manner
consistent with the Fund's objective.
MONTHLY DISTRIBUTIONS TO FUND SHAREHOLDERS
The Fund makes monthly distributions of income to shareholders consistent
with the objective of the Fund to provide high current income. The Fund is a
regulated investment company, and as such, there are a number of tax laws that
require the Fund to distribute almost all of its net investment income to
shareholders each year. If the Fund were to not satisfy the minimum
distribution requirements, it could risk its pass-through status and perhaps
face financial penalties.
Even though these rules are well-defined, we still believe that there is a
bit of art involved in setting dividend policy. One approach to distributions
would be for the Fund to simply pay out its net earnings each month. Because of
the uneven nature of the Fund's income and expenses, this would likely result in
distribution rates that would change every month. This approach has never
seemed terribly appealing to us.
We believe our shareholders are better served by a more stable level of
monthly distributions. In striving for more stability and to reflect the
inherent uncertainty in predicting future net earnings, in any particular month
the Fund may pay out less than the amount earned for the same month; in other
months the distribution may be comprised of current month's earnings PLUS
income from prior months.
The rules mentioned above also impose a specific time-frame on the
decisions about distributions, as they require true-up over each fiscal year. If
the Fund has excess income at the end of this annual period, the Fund must make
decisions that balance the goal of income stability and the requirements imposed
by law. The Fund has always met the legal distribution requirements, but many
times in the past the Fund has decided to not exceed the minimum requirements
with the intent of "carrying over" a bit of income to the next fiscal-year
period. Given that the minimum requirements are quite high, the carryover can
never be more than a modest amount (less than one-month's dividend). There is an
economic cost associated with this decision in the form of an excise tax on
portions of the undistributed amounts, but we believe this cost is minimal and
more than offset by the benefits of a more stable distribution rate over time.
Details on the amount of undistributed net investment income and the incurrence
of any related excise tax, if applicable, are avail-able in the Notes to the
financial statements.
8
As mentioned above, we believe this is more art than science, but the goal
of high current income that is sustainable over a reasonable period of time
seems to us consistent with trying to maximize value over the long-run for
shareholders.
FEDERAL TAX ADVANTAGES OF 2010 CALENDAR YEAR DISTRIBUTIONS
In 2010, the Fund passed on a portion of its income to individuals in the
form of qualified dividend income or QDI. Under federal law, QDI is taxed at a
maximum 15% rate instead of an individual's ordinary income tax rate. As a
result of recent changes to the Internal Revenue Code, it is expected that this
favorable tax rate for QDI will continue through 2012.
In calendar year 2010, approximately 49% of distributions made by the Fund
was eligible for QDI treatment. For an individual in the 28% marginal tax
bracket, this means that the Fund's total distributions will only be taxed at a
blended 21.7% rate versus the 28% rate which would apply to distributions by a
fund containing traditional corporate bonds. This tax advantage means that, all
other things being equal, such an individual who held 100 shares of Common
Stock of the Fund for the calendar year would have had to receive approximately
$89 in distributions from a traditional corporate bond fund to net the same
after-tax amount as the $82 distributions paid by the Fund.
For detailed information about the tax treatment of the particular
distributions received from the Fund, please see the Form 1099 you receive from
either the Fund or your broker.
Corporate shareholders also receive a federal tax benefit from the 19.6% of
distributions that were eligible for the inter-corporate, dividends received
deduction or DRD.
It is important to remember that the composition of the portfolio and the
income distributions can change from one year to the next, and that the QDI or
DRD portions of 2011's distributions may not be the same (or even similar) to
2010.
STATUS OF THE FUND'S HEDGING STRATEGY
The Fund suspended its interest rate hedging program as the financial
crisis intensified in the autumn of 2008. There were three principal reasons why
we suspended the program at the time. First, the relationship between preferred
securities' prices and the Fund's hedging instruments (Treasury bond futures,
interest rate swaps, and options on both) was turned on its head during the
financial crisis. Historically, preferred prices had tended to rise (fall) in
periods of falling (rising) long-term Treasury rates, but as the financial
crisis unfolded, the opposite occurred: preferred prices plunged while Treasury
and swap rates fell as investors sold risky assets and raced into Treasuries.
Hedging lost its effectiveness. Second, the cost of hedging rose dramatically
as the yield curve steepened and options prices rose sharply. Finally, preferred
securities became exceptionally cheap and were likely to offer high returns to
shareholders even if Treasury yields increased moderately. Add them up, and we
believed that hedging simply would not work under market conditions at the time.
Looking at the hedging strategy currently, we conclude that it remains too
early to reinstate the hedging program. Although some preferred securities are
starting to move in concert with the general level of long-term Treasury rates,
many are not. For the preferred market as a whole, correlations between
movements in prices of preferreds and the hedge instruments we use are
increasing. However, they are too unstable to convince us that portfolio
hedging would be reliably effective. Meanwhile, the cost of hedging is high, and
preferreds continue to be attractively priced. At some point we expect that
these circumstances will change. When they do, we will consider hedging again
and may implement hedges prior to being able to communicate such a change to
shareholders in our regular quarterly reporting.
9
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OVERVIEW
NOVEMBER 30, 2010 (UNAUDITED)
FUND STATISTICS
---------------
Net Asset Value $ 9.72
Market Price $ 9.89
Premium 1.75%
Yield on Market Price 8.80%
Common Stock Shares
Outstanding 11,993,491
MOODY'S RATINGS % OF NET ASSETS+
--------------- ----------------
A 5.8%
BBB 71.3%
BB 20.4%
Below "BB" 0.8%
Not Rated* 0.2%
Below Investment Grade** 16.4%
* Does not include net other assets and liabilities of 1.5%.
** Below investment grade by both Moody's and S&P.
(PIE CHART)
INDUSTRY CATEGORIES % OF NET ASSETS+
------------------- ----------------
Banking 38%
Utilities 26%
Insurance 24%
Energy 7%
Financial Services 2%
Other 3%
TOP 10 HOLDINGS BY ISSUER % OF NET ASSETS+
------------------------- ----------------
Liberty Mutual Group 4.5%
Banco Santander 4.4%
Capital One Financial 4.2%
Wells Fargo 3.9%
Metlife 3.1%
Enbridge Energy Partners 3.1%
Barclays Bank Plc 2.8%
HSBC Plc 2.7%
Puget Energy 2.6%
PNC Financial Services 2.5%
% OF NET ASSETS***+
-------------------
Holdings Generating Qualified Dividend Income (QDI) for Individuals 40%
Holdings Generating Income Eligible for the Corporate Dividends Received Deduction (DRD) 26%
*** This does not reflect year-end results or actual tax categorization of Fund
distributions. These percentages can, and do, change, perhaps
significantly, depending on market conditions. Investors should consult
their tax advisor regarding their personal situation.
See accompanying notes to financial statements for the tax characterization
of 2010 distributions.
+ Net Assets includes assets attributable to the use of leverage.
10
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
PREFERRED SECURITIES -- 95.9%
BANKING -- 37.9%
$ 2,750,000 Astoria Capital Trust I, 9.75% 11/01/29, Series B ........................................ 2,865,063(1)
280,123 Banco Santander, 10.50% Pfd., Series 10 .................................................. 7,615,844**(1)(2)
7,500 Bank of America Corporation, 8.625% Pfd. ................................................. 188,025*
$ 500,000 BankAmerica Institutional, Series A, 8.07% 12/31/26, 144A**** ............................ 506,250
Barclays Bank PLC:
$ 2,750,000 6.278% ................................................................................ 2,420,000**(1)(2)
25,000 6.625% Pfd., Series 2 ................................................................. 582,000**(1)(2)
1,200 7.75% Pfd., Series 4 .................................................................. 30,528**(2)
70,000 8.125% Pfd., Series 5 ................................................................. 1,806,000**(1)(2)
59,000 BB&T Capital Trust VI, 9.60% Pfd. 08/01/64 ............................................... 1,649,640(1)
$ 1,375,000 BBVA International Preferred, 5.919% ..................................................... 1,108,126**(2)
$ 700,000 BNP Paribas, 7.195%, 144A**** ............................................................ 698,250**(2)
$ 5,000,000 Capital One Capital III, 7.686% 08/15/36 ................................................. 5,050,000(1)
$ 250,000 Capital One Capital V, 10.25% 08/15/39 ................................................... 265,937
$ 1,750,000 Capital One Capital VI, 8.875% 05/15/40 .................................................. 1,841,875(1)
56,700 Citigroup Capital XIII, 7.875% Pfd. 10/30/40 ............................................. 1,497,589
$ 4,500,000 Colonial BancGroup, 7.114%, 144A**** ..................................................... 113,850++
4,500 FBOP Corporation, Adj. Rate Pfd., 144A**** ............................................... 19,908*+(3)
$ 700,000 Fifth Third Capital Trust IV, 6.50% 04/15/37 ............................................. 656,250(1)
125,000 Fifth Third Capital Trust VI, 7.25% Pfd. 11/15/67 ........................................ 3,129,063
14,600 Fifth Third Capital Trust VII, 8.875% Pfd. 05/15/68 ...................................... 377,775
890 First Republic Preferred Capital Corporation, 10.50% Pfd., 144A**** ...................... 919,370
22,500 First Republic Preferred Capital Corporation II, 8.75% Pfd., Series B, 144A**** .......... 574,454
3,750 First Tennessee Bank, Adj. Rate Pfd., 144A**** ........................................... 2,341,406*(1)
$ 400,000 First Tennessee Capital I, 8.07% 01/06/27, Series A ...................................... 377,821
$ 500,000 First Tennessee Capital II, 6.30% 04/15/34, Series B ..................................... 375,813
$ 2,325,000 First Union Institutional Capital I, 8.04% 12/01/26 ...................................... 2,382,660(1)
$ 350,000 Fleet Capital Trust II, 7.92% 12/11/26 ................................................... 353,500
Goldman Sachs:
$ 400,000 Capital I, 6.345% 02/15/34 ............................................................ 374,224(1)
$ 1,163,000 Capital II, 5.793% .................................................................... 988,550(1)
3,500 STRIPES Custodial Receipts, Pvt ....................................................... 2,362,500*(3)
109,200 HSBC Holdings PLC, 8.00% Pfd., Series 2 .................................................. 2,951,818**(1)(2)
HSBC USA, Inc.:
45,000 6.50% Pfd., Series H .................................................................. 1,117,971*(1)
4,400 $2.8575 Pfd. .......................................................................... 209,688*(1)
$ 725,000 JPMorgan Chase Capital XVIII, 6.95% 08/17/36, Series R ................................... 729,335
The accompanying notes are an integral part of the financial statements.
11
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
PREFERRED SECURITIES -- (CONTINUED)
BANKING -- (CONTINUED)
16,700 Keycorp Capital VIII, 7.00% Pfd. 06/15/66 ................................................ $ 413,851(1)
65,000 Keycorp Capital IX, 6.75% Pfd. 12/15/66 .................................................. 1,617,948
25,200 Keycorp Capital X, 8.00% Pfd. 03/15/68 ................................................... 648,900(1)
$ 450,000 Lloyds Banking Group PLC, 6.657%, 144A**** ............................................... 303,750**(2)+
13,000 National City Capital Trust II, 6.625% Pfd. 11/15/36 ..................................... 325,163
$ 840,000 NB Capital Trust IV, 8.25% 04/15/27 ...................................................... 852,600(1)
99,000 PNC Financial Services, 9.875% Pfd., Series L ............................................ 2,762,724*(1)
$ 1,105,000 PNC Preferred Funding Trust III, 8.70%, 144A**** ......................................... 1,189,551(1)
2,600 Sovereign REIT, 12.00% Pfd., Series A, 144A**** .......................................... 2,970,500
$ 1,100,000 Wachovia Capital Trust III, 5.80% ........................................................ 935,000(1)
$ 800,000 Wachovia Capital Trust V, 7.965% 06/01/27, 144A**** ...................................... 807,758
$ 900,000 Washington Mutual, 9.75%, 144A**** ....................................................... 31,500++
$ 1,400,000 Webster Capital Trust IV, 7.65% 06/15/37 ................................................. 1,216,582(1)
35,000 Wells Fargo & Company, 8.00% Pfd., Series J .............................................. 935,550*
$ 1,500,000 Wells Fargo Capital XV, 9.75% ............................................................ 1,678,125(1)
-------------
65,170,585
-------------
FINANCIAL SERVICES -- 1.8%
$ 250,000 Ameriprise Financial, Inc., 7.518% 06/01/66 .............................................. 260,625(1)
27,000 Heller Financial, Inc., 6.687% Pfd., Series C ............................................ 2,599,595*
12,400 HSBC Finance Corporation, 6.36% Pfd. ..................................................... 291,307*
Lehman Brothers Holdings, Inc.:
45,800 5.67% Pfd., Series D ..................................................................... 12,595*++
9,500 5.94% Pfd., Series C ..................................................................... 2,565*++
25,000 6.50% Pfd., Series F ..................................................................... 1,813*++
13,400 7.95% Pfd. ............................................................................... 214*++
-------------
3,168,714
-------------
INSURANCE -- 21.3%
$ 1,200,000 Ace Capital Trust II, 9.70% 04/01/30 ..................................................... 1,464,628(1)(2)
$ 225,000 AON Corporation, 8.205% 01/01/27 ......................................................... 238,572
Arch Capital Group Ltd.:
14,400 7.875% Pfd., Series B .................................................................... 365,638**(1)(2)
25,000 8.00% Pfd., Series A ..................................................................... 637,500**(1)(2)
AXA SA:
$ 1,250,000 6.379%, 144A**** ......................................................................... 1,162,500**(1)(2)
$ 2,750,000 6.463%, 144A**** ......................................................................... 2,530,000**(1)(2)
The accompanying notes are an integral part of the financial statements.
12
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
PREFERRED SECURITIES -- (CONTINUED)
INSURANCE -- (CONTINUED)
29,700 Axis Capital Holdings, 7.50% Pfd., Series B .............................................. $ 2,743,537(1)(2)
90,000 Delphi Financial Group, 7.376% Pfd. 05/15/37 ............................................. 2,106,567(1)
$ 4,000,000 Everest Re Holdings, 6.60% 05/15/37 ...................................................... 3,800,000(1)
$ 4,600,000 Liberty Mutual Group, 10.75% 06/15/58, 144A**** .......................................... 5,658,000(1)
$ 2,203,000 MetLife Capital Trust X, 9.25% 04/08/38, 144A**** ........................................ 2,616,062(1)
$ 2,000,000 MetLife, Inc., 10.75% 08/01/39 ........................................................... 2,701,954(1)
Principal Financial Group:
26,000 5.563% Pfd., Series A ................................................................. 2,387,125*(1)
62,500 6.518% Pfd., Series B ................................................................. 1,558,594*(1)
50,400 Renaissancere Holdings Ltd., 6.08% Pfd., Series C ........................................ 1,153,152**(1)(2)
115,500 Scottish Re Group Ltd., 7.25% Pfd. ....................................................... 988,969**(2)+
$ 1,000,000 Stancorp Financial Group, 6.90% 06/01/67 ................................................. 961,229(1)
$ 1,060,000 USF&G Capital, 8.312% 07/01/46, 144A**** ................................................. 1,157,948(1)
$ 1,700,000 XL Capital Ltd., 6.50%, Series E ......................................................... 1,466,250(1)(2)
$ 1,000,000 ZFS Finance USA Trust V, 6.50% 05/09/37, 144A**** ........................................ 977,500(1)
-------------
36,675,725
-------------
UTILITIES -- 26.0%
6,579 Baltimore Gas & Electric Company, 6.70% Pfd., Series 1993 ................................ 655,433*(1)
8,900 Calenergy Capital Trust III, 6.50% Pfd. 09/01/27 ......................................... 441,885
$ 2,750,000 COMED Financing III, 6.35% 03/15/33 ...................................................... 2,388,655(1)
$ 750,000 Dominion Resources Capital Trust I, 7.83% 12/01/27 ....................................... 770,784(1)
$ 3,000,000 Dominion Resources, Inc., 7.50% 06/30/66 ................................................. 3,123,534(1)
40,000 Entergy Arkansas, Inc., 6.45% Pfd. ....................................................... 986,252*
10,000 Entergy Louisiana, Inc., 6.95% Pfd. ...................................................... 979,063*
80,000 Entergy Mississippi, Inc., 6.25% Pfd. .................................................... 1,995,000*
FPL Group Capital, Inc.:
$ 2,000,000 6.65% 06/15/67 ........................................................................ 1,977,578(1)
$ 1,000,000 7.30% 09/01/67, Series D .............................................................. 1,028,860(1)
17,500 Georgia Power Company, 6.50% Pfd., Series 2007A .......................................... 1,865,391*(1)
Gulf Power Company:
16,500 6.00% Pfd., Series 1 .................................................................. 1,654,118*(1)
13,000 6.45% Pfd., Series 2007A .............................................................. 1,355,939*(1)
30,500 Indianapolis Power & Light Company, 5.65% Pfd. ........................................... 2,864,142*(1)
140,485 Interstate Power & Light Company, 8.375% Pfd., Series B .................................. 4,073,011*(1)
7,000 MDU Resources Group, 4.50% Pfd. 07/08/10 ................................................. 570,500*
10,935 Pacific Enterprises, $4.50 Pfd. .......................................................... 923,666*(1)
The accompanying notes are an integral part of the financial statements.
13
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
PREFERRED SECURITIES -- (CONTINUED)
UTILITIES -- (CONTINUED)
$ 1,500,000 PECO Energy Capital Trust III, 7.38% 04/06/28, Series D .................................. $ 1,457,179(1)
$ 4,500,000 Puget Sound Energy, Inc., 6.974% 06/01/67 ................................................ 4,417,434(1)
Southern California Edison:
27,500 6.00% Pfd., Series C .................................................................. 2,670,080*(1)
15,000 6.125% Pfd. ........................................................................... 1,494,375*
$ 1,835,000 Southern Union Company, 7.20% 11/01/66 ................................................... 1,688,200(1)
$ 750,000 TXU Electric Capital V, 8.175% 01/30/37 .................................................. 200,625(3)
8,265 Union Electric Company, $4.75 Pfd. ....................................................... 609,802*
$ 2,000,000 Wisconsin Energy Corporation, 6.25% 05/15/67 ............................................. 1,962,560(1)
$ 2,500,000 WPS Resources Corporation, 6.11% 12/01/66 ................................................ 2,427,990(1)
-------------
44,582,056
-------------
ENERGY -- 7.0%
$ 5,000,000 Enbridge Energy Partners LP, 8.05% 10/01/37 .............................................. 5,252,740(1)
Enterprise Products Partners:
$ 750,000 7.00% 06/01/67 ........................................................................ 738,478
$ 2,750,000 8.375% 08/01/66, Series A ............................................................. 2,925,167(1)
3,000 Kinder Morgan GP, Inc., 8.33% Pfd., 144A**** ............................................. 3,126,750*
-------------
12,043,135
-------------
REAL ESTATE INVESTMENT TRUST (REIT) -- 0.2%
12,500 PS Business Parks, Inc., 6.70% Pfd., Series P ............................................ 307,531
-------------
307,531
-------------
MISCELLANEOUS INDUSTRIES -- 1.7%
35,000 Ocean Spray Cranberries, Inc., 6.25% Pfd., 144A**** ...................................... 2,891,875*(1)
-------------
2,891,875
-------------
TOTAL PREFERRED SECURITIES
(Cost $159,061,639) ................................................................... 164,839,621
-------------
CORPORATE DEBT SECURITIES -- 2.6%
FINANCIAL SERVICES -- 0.2%
15,000 Goldman Sachs Group, 6.125% 11/01/60 ..................................................... 358,595
-------------
358,595
-------------
The accompanying notes are an integral part of the financial statements.
14
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2010
SHARES/$ PAR VALUE
------------- -------------
CORPORATE DEBT SECURITIES -- (CONTINUED)
INSURANCE -- 2.4%
$ 2,250,000 Liberty Mutual Insurance, 7.697% 10/15/97, 144A**** ............................ $ 2,043,254(1)
$ 2,000,000 UnumProvident Corporation, 7.25% 03/15/28 ...................................... 2,074,060(1)
-------------
4,117,314
-------------
TOTAL CORPORATE DEBT SECURITIES
(Cost $3,569,316) ........................................................... 4,475,909
-------------
MONEY MARKET FUND -- 0.4%
696,706 BlackRock Liquidity Funds, T-Fund .............................................. 696,706
-------------
TOTAL MONEY MARKET FUND
(Cost $696,706) ............................................................. 696,706
-------------
TOTAL INVESTMENTS (Cost $163,327,661***) ....................................................... 98.9% 170,012,236
OTHER ASSETS AND LIABILITIES (Net) ............................................................. 1.1% 1,810,866
----- -------------
NET ASSETS BEFORE LOAN ......................................................................... 100.0%+++ $ 171,823,102
----- -------------
LOAN PRINCIPAL BALANCE ......................................................................... (55,200,000)
-------------
TOTAL NET ASSETS AVAILABLE TO COMMON STOCK ..................................................... $ 116,623,102
=============
----------
* Securities eligible for the Dividends Received Deduction and distributing
Qualified Dividend Income.
** Securities distributing Qualified Dividend Income only.
*** Aggregate cost of securities held.
**** Securities exempt from registration under Rule 144A of the Securities Act
of 1933. These securities may be resold in transactions exempt from
registration to qualified institutional buyers. At November 30, 2010, these
securities amounted to $32,640,436 or 19.0% of net assets before loan.
(1) All or a portion of this security is pledged as collateral for the Fund's
loan. The total value of such securities was $120,671,102 at November 30,
2010.
(2) Foreign Issuer.
(3) Illiquid
+ Non-income producing.
++ The issuer has filed for bankruptcy protection. As a result, the Fund may
not be able to recover the principal invested and also does not expect to
receive income on this security going forward.
+++ The percentage shown for each investment category is the total value of
that category as a percentage of net assets before the loan.
ABBREVIATIONS:
PFD. -- Preferred Securities
PVT. -- Private Placement Securities
REIT -- Real Estate Investment Trust
STRIPES -- Structured Residual Interest Preferred Enhanced Securities
The accompanying notes are an integral part of the financial statements.
15
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
STATEMENT OF ASSETS AND LIABILITIES
NOVEMBER 30, 2010
ASSETS:
Investments, at value (Cost $163,327,661) .................. $170,012,236
Dividends and interest receivable .......................... 2,293,900
Prepaid expenses ........................................... 55,199
------------
Total Assets ............................................ 172,361,335
LIABILITIES:
Loan Payable ................................................ $ 55,200,000
Payable for investments purchased ........................... 244,985
Dividends payable to Common Stock Shareholders .............. 93,345
Investment advisory fee payable ............................. 81,283
Administration, Transfer Agent and Custodian fees payable ... 26,208
Professional fees payable ................................... 62,520
Directors' fees payable ..................................... 1,282
Accrued expenses and other payables ......................... 28,610
------------
Total Liabilities ....................................... 55,738,233
------------
NET ASSETS AVAILABLE TO COMMON STOCK .......................... $116,623,102
============
NET ASSETS AVAILABLE TO COMMON STOCK consist of:
Undistributed net investment income ........................ $ 514,304
Accumulated net realized loss on investments sold .......... (29,346,204)
Unrealized appreciation of investments ..................... 6,684,575
Par value of Common Stock .................................. 119,935
Paid-in capital in excess of par value of Common Stock ..... 138,650,492
------------
Total Net Assets Available to Common Stock .............. $116,623,102
============
NET ASSET VALUE PER SHARE OF COMMON STOCK:
Common Stock (11,993,491 shares outstanding) ............... $ 9.72
============
The accompanying notes are an integral part of the financial statements.
16
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED NOVEMBER 30, 2010
INVESTMENT INCOME:
Dividends+ .................................................... $ 5,800,708
Interest ...................................................... 7,266,500
-----------
Total Investment Income .................................... 13,067,208
EXPENSES:
Investment advisory fees ...................................... $ 928,572
Administrator's fees .......................................... 167,890
Professional fees ............................................. 114,918
Insurance expenses ............................................ 108,162
Transfer Agent fees ........................................... 50,193
Directors' fees ............................................... 71,898
Custodian fees ................................................ 24,096
Compliance fees ............................................... 37,697
Interest expense .............................................. 778,199
Other ......................................................... 218,554
-----------
Total Expenses
2,500,179
-----------
NET INVESTMENT INCOME
10,567,029
-----------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
Net realized gain on investments sold during the year ......... 2,893,764
Change in net unrealized appreciation/depreciation
of investments ............................................. 16,663,789
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS .................. 19,557,553
-----------
DISTRIBUTIONS TO AUCTION PREFERRED STOCK SHAREHOLDERS:
From net investment income (including changes in accumulated
undeclared distributions) .................................. (73,485)
-----------
NET INCREASE IN NET ASSETS TO COMMON STOCK
RESULTING FROM OPERATIONS ..................................... $30,051,097
===========
----------
+ For Federal income tax purposes, a significant portion of this amount may
not qualify for the inter-corporate dividends received deduction ("DRD") or
as qualified dividend income ("QDI") for individuals.
The accompanying notes are an integral part of the financial statements.
17
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
STATEMENTS OF CHANGES IN NET ASSETS AVAILABLE TO COMMON STOCK
YEAR ENDED YEAR ENDED
NOVEMBER 30, 2010 NOVEMBER 30, 2009
----------------- -----------------
OPERATIONS:
Net investment income .............................................. $ 10,567,029 $ 8,629,588
Net realized gain/(loss) on investments sold during the year ....... 2,893,764 (13,670,524)
Change in net unrealized appreciation/depreciation of investments .. 16,663,789 51,997,405
Distributions to APS* Shareholders from net investment income,
including changes in accumulated undeclared distributions ....... (73,485) (936,183)
------------ ------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS ............... 30,051,097 46,020,286
DISTRIBUTIONS:
Dividends paid from net investment income to Common Stock
Shareholders(1) ................................................. (9,263,572) (7,125,108)
------------ ------------
TOTAL DISTRIBUTIONS TO COMMON STOCK SHAREHOLDERS ................... (9,263,572) (7,125,108)
FUND SHARE TRANSACTIONS:
Increase from shares issued under the Dividend Reinvestment
and Cash Purchase Plan .......................................... 817,031 375,985
------------ ------------
NET INCREASE IN NET ASSETS AVAILABLE TO COMMON STOCK RESULTING
FROM FUND SHARE TRANSACTIONS .................................... 817,031 375,985
------------ ------------
NET INCREASE IN NET ASSETS AVAILABLE TO COMMON STOCK FOR THE YEAR ..... $ 21,604,556 $ 39,271,163
============ ============
NET ASSETS AVAILABLE TO COMMON STOCK:
Beginning of year .................................................. $ 95,018,546 $ 55,747,383
Net increase in net assets during the year ......................... 21,604,556 39,271,163
------------ ------------
End of year (including undistributed net investment income
of $514,304 and distributions in excess of net investment
income of $(170,225), respectively) ............................. $116,623,102 $ 95,018,546
============ ============
----------
* Auction Preferred Stock.
(1) May include income earned, but not paid out, in prior fiscal year.
The accompanying notes are an integral part of the financial statements.
18
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED NOVEMBER 30, 2010
INCREASE/(DECREASE) IN CASH
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase in net assets resulting from operations .............. $ 30,051,097
ADJUSTMENTS TO RECONCILE NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Purchase of investment securities ................................. (67,030,360)
Proceeds from disposition of investment securities ................ 55,131,417
Sale of short-term investment securities, net ..................... 2,240,081
Cash received from litigation claim ............................... 34,177
Increase in dividends and interest receivable ..................... (293,078)
Decrease in prepaid expenses ...................................... 137,323
Net amortization/(accretion) of premium/(discount) ................ (601,491)
Increase in payable for investments purchased ..................... 244,985
Increase in payables to related parties ........................... 12,815
Increase in accrued expenses and other liabilities ................ 4,030
Change in net unrealized appreciation/depreciation on securities .. (16,663,789)
Net realized gain from investments sold ........................... (2,893,764)
------------
Net cash provided by operating activities ...................... 373,443
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from loan ................................................ 8,200,000
Decrease in payable for APS ....................................... (155,561)
Dividends paid (net of reinvestment of dividends and change in
dividends payable) to common stock shareholders from net
investment income .............................................. (8,417,882)
------------
Net cash used by financing activities .......................... (373,443)
------------
Net increase/(decrease) in cash ................................ --
CASH:
Beginning of the year ............................................. --
------------
End of the year ................................................... $ --
============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid during the year ..................................... $ 781,161
Reinvestment of dividends ......................................... 817,031
Increase in dividends payable to common stock shareholders ........ 28,659
The accompanying notes are an integral part of the financial statements.
19
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
FINANCIAL HIGHLIGHTS
FOR A COMMON STOCK SHARE OUTSTANDING THROUGHOUT EACH YEAR.
Contained below is per share operating performance data, total investment
returns, ratios to average net assets and other supplemental data. This
information has been derived from information provided in the financial
statements and market price data for the Fund's shares.
YEAR ENDED NOVEMBER 30,
---------------------------------------------------
2010 2009 2008 2007 2006
-------- -------- -------- -------- --------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year .................................. $ 7.98 $ 4.71 $ 10.14 $ 12.60 $ 12.14
-------- -------- -------- -------- --------
INVESTMENT OPERATIONS:
Net investment income ............................................... 0.89 0.73 1.00 1.06 1.02
Net realized and unrealized gain/(loss) on investments .............. 1.64 3.22 (5.46) (2.44) 0.49
DISTRIBUTIONS TO APS* SHAREHOLDERS:
From net investment income .......................................... (0.01) (0.08) (0.33) (0.29) (0.25)
-------- -------- -------- -------- --------
Total from investment operations .................................... 2.52 3.87 (4.79) (1.67) 1.26
-------- -------- -------- -------- --------
DISTRIBUTIONS TO COMMON STOCK SHAREHOLDERS:
From net investment income .......................................... (0.78) (0.60) (0.75) (0.79) (0.80)
From return of capital .............................................. -- -- (0.03) -- --
-------- -------- -------- -------- --------
Total distributions to Common Stock Shareholders .................... (0.78) (0.60) (0.78) (0.79) (0.80)
-------- -------- -------- -------- --------
Gain on repurchase of Auction Preferred Stock ....................... -- -- 0.14 -- --
-------- -------- -------- -------- --------
Net asset value, end of year ........................................ $ 9.72 $ 7.98 $ 4.71 $ 10.14 $ 12.60
======== ======== ======== ======== ========
Market value, end of year ........................................... $ 9.89 $ 7.44 $ 3.93 $ 10.30 $ 12.42
Total investment return based on net asset value** .................. 32.37% 88.38% (48.12%) (13.90%) 11.02%
Total investment return based on market value** ..................... 44.46% 110.49% (57.38%) (11.28%) 15.22%
RATIOS TO AVERAGE NET ASSETS AVAILABLE
TO COMMON STOCK SHAREHOLDERS:
Total net assets, end of year (in 000's) ......................... $116,623 $ 95,019 $ 55,747 $119,086 $147,357
Operating expenses including interest expense(1) ................. 2.32% 2.55% -- -- --
Operating expenses excluding interest expense .................... 1.60% 2.19% 2.05% 1.56% 1.52%
Net investment income + .......................................... 9.81% 12.38% -- -- --
Net investment income, including payments to APS Shareholders + .. 9.74% 11.03% 8.36% 6.53% 6.34%
SUPPLEMENTAL DATA: ++
Portfolio turnover rate .......................................... 35% 66% 60% 60% 68%
Net assets before loan, end of year (in 000's) ................... $171,823 $142,019 $105,347 $189,086 $217,357
Ratio of operating expenses including interest expense(1)(2) to
net assets before loan and APS ................................ 1.55% 1.59% -- -- --
Ratio of operating expenses excluding interest expense(2) to
net assets before loan and APS ................................ 1.07% 1.36% 1.19% 1.04% 1.02%
----------
* Auction Preferred Stock.
** Assumes reinvestment of distributions at the price obtained by the Fund's
Dividend Reinvestment and Cash Purchase Plan.
+ The net investment income ratios reflect income net of operating expenses,
including interest expense.
++ Information presented under heading Supplemental Data includes APS and loan
principal balance.
(1) See Note 8.
(2) Does not include distributions to APS Shareholders.
The accompanying notes are an integral part of the financial statements.
20
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
FINANCIAL HIGHLIGHTS (CONTINUED)
PER SHARE OF COMMON STOCK
TOTAL DIVIDEND
DIVIDENDS NET ASSET NYSE REINVESTMENT
PAID VALUE CLOSING PRICE PRICE (1)
--------- --------- ------------- ------------
December 31, 2009 ... $0.0575 $8.39 $ 8.27 $ 8.36
January 29, 2010 .... 0.0575 8.57 8.33 8.43
February 26, 2010 ... 0.0575 8.68 8.86 8.68
March 31, 2010 ...... 0.0575 9.06 9.95 9.45
April 30, 2010 ...... 0.0575 9.20 10.15 9.64
May 28, 2010 ........ 0.0660 8.59 9.60 9.12
June 30, 2010 ....... 0.0660 8.69 9.39 8.92
July 30, 2010 ....... 0.0660 9.10 9.95 9.45
August 31, 2010 ..... 0.0725 9.36 10.18 9.67
September 30, 2010 .. 0.0725 9.64 10.66 10.13
October 29, 2010 .... 0.0725 9.82 10.20 9.82
November 30, 2010 ... 0.0725 9.72 9.89 9.73
----------
(1) Whenever the net asset value per share of the Fund's Common Stock is less
than or equal to the market price per share on the reinvestment date, new
shares issued will be valued at the higher of net asset value or 95% of the
then current market price. Otherwise, the reinvestment shares of Common
Stock will be purchased in the open market.
The accompanying notes are an integral part of the financial statements.
21
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
FINANCIAL HIGHLIGHTS (CONTINUED)
SENIOR SECURITIES
INVOLUNTARY
ASSET LIQUIDATION TOTAL DEBT ASSET
COVERAGE PREFERENCE OUTSTANDING COVERAGE PER
TOTAL APS* SHARES PER APS PER APS END OF PERIOD $1,000 OF
DATE OUTSTANDING (1) SHARE (2) SHARE (3) (000S) (4) DEBT (5)
-------- ----------------- --------- ----------- ------------- ------------
11/30/10 -- N/A N/A $55,200 $3,113
11/30/09 -- N/A N/A 47,000 3,022
11/30/08 496 $214,002 $100,000 N/A N/A
11/30/07 700 270,894 100,000 N/A N/A
11/30/06 700 310,819 100,000 N/A N/A
----------
(1) See note 7.
(2) Calculated by subtracting the Fund's total liabilities (excluding the APS
and accumulated undeclared distributions to APS) from the Fund's total
assets and dividing that amount by the number of APS shares outstanding.
(3) Excludes accumulated undeclared dividends.
(4) See note 8.
(5) Calculated by subtracting the Fund's total liabilities (excluding the loan)
from the Fund's total assets and dividing that amount by the loan
outstanding in 000's.
* Auction Preferred Stock.
The accompanying notes are an integral part of the financial statements.
22
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated (the
"Fund") was incorporated as a Maryland corporation on December 10, 1991, and
commenced operations on February 13, 1992 as a diversified, closed-end
management investment company under the Investment Company Act of 1940, as
amended (the "1940 Act"). The Fund's investment objective is to provide its
common shareholders with high current income consistent with the preservation of
capital.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of the financial statements is in conformity with U.S. generally
accepted accounting principles ("US GAAP") and requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities in the financial statements and the reported amounts of increases
and decreases in net assets from operations during the reporting period. Actual
results could differ from those estimates.
PORTFOLIO VALUATION: The net asset value of the Fund's Common Stock is
determined by the Fund's Administrator no less frequently than on the last
business day of each week and month in accordance with the policies and
procedures approved by the Board of Directors of the Fund. It is determined by
dividing the value of the Fund's net assets available to Common Stock by the
number of shares of Common Stock outstanding. The value of the Fund's net assets
available to Common Stock is deemed to equal the value of the Fund's total
assets less (i) the Fund's liabilities and (ii) the aggregate liquidation value
of any outstanding preferred stock.
The Fund's preferred and debt securities are valued on the basis of current
market quotations provided by independent pricing services or dealers approved
by the Board of Directors of the Fund. Each quotation is based on the mean of
the bid and asked prices of a security. In determining the value of a particular
preferred or debt security, a pricing service or dealer may use information with
respect to transactions in such investments, quotations, market transactions in
comparable investments, various relationships observed in the market between
investments, and/or calculated yield measures based on valuation technology
commonly employed in the market for such investments. Common stocks that are
traded on stock exchanges are valued at the last sale price or official close
price on the exchange, as of the close of business on the day the securities are
being valued or, lacking any sales, at the last available mean price. Futures
contracts and option contracts on futures contracts are valued on the basis of
the settlement price for such contracts on the primary exchange on which they
trade. Investments in over-the-counter derivative instruments, such as interest
rate swaps and options thereon ("swaptions"), are valued using prices supplied
by a pricing service, or if such prices are unavailable, prices provided by a
single broker or dealer that is not the counterparty or, if no such prices are
available, at a price at which the counterparty to the contract would repurchase
the instrument or terminate the contract. Investments for which market
quotations are not readily available or for which management determines that the
prices are not reflective of current market conditions are valued at fair value
as determined in good faith by or under the direction of the Board of Directors
of the Fund, including reference to valuations of other securities which are
comparable in quality, maturity and type.
23
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Investments in money market instruments and all debt and preferred
securities which mature in 60 days or less are valued at amortized cost.
Investments in money market funds are valued at the net asset value of such
funds.
FAIR VALUE MEASUREMENT: The inputs and valuation techniques used to measure
fair value of the Fund's investments are summarized into three levels as
described in the hierarchy below:
- Level 1 - quoted prices in active markets for identical securities
- Level 2 - other significant observable inputs (including quoted prices
for similar securities, interest rates, prepayment speeds,
credit risk, etc.)
- Level 3 - significant unobservable inputs (including the Fund's own
assumptions in determining the fair value of investments)
The inputs or methodology used for valuing securities are not necessarily
an indication of the risk associated with investing in those securities.
Transfers in and out of levels are recognized at market value at the end of the
period. A summary of the inputs used to value the Fund's investments as of
November 30, 2010 is as follows:
LEVEL 2 LEVEL 3
TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
NOVEMBER 30, 2010 PRICE INPUTS INPUTS
----------------- ----------- ------------ ------------
Preferred Securities
Banking $ 65,170,585 $42,015,149 $ 23,135,528 $19,908
Financial Services 3,168,714 291,307 2,877,407 --
Insurance 36,675,725 12,128,436 24,547,289 --
Utilities 44,582,056 7,196,545 37,385,511 --
Energy 12,043,135 -- 12,043,135 --
Real Estate Investment Trust (REIT) 307,531 307,531 -- --
Miscellaneous Industries 2,891,875 -- 2,891,875 --
Corporate Debt Securities 4,475,909 358,595 4,117,314 --
Money Market Fund 696,706 696,706 -- --
------------ ----------- ------------ -------
Total Investments $170,012,236 $62,994,269 $106,998,059 $19,908
============ =========== ============ =======
The Fund did not have any significant transfers in and out of Level 1 and
Level 2 during the period.
The Fund's investments in Level 2 and Level 3 are based primarily on market
information, where available. This includes, but is not limited to, prices
provided by third-party providers, observable trading activity (including the
recency, depth, and consistency of such information with quoted levels), and the
depth and consistency of broker-quoted prices. In the event market information
is not directly available, compara-ble information may be observed for
securities that are similar in many respects to those being valued. The Fund may
employ an income approach for certain securities that also takes into account
credit risk, interest rate risk, and potential recovery prospects.
24
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The following is a reconciliation of Level 3 investments for which
significant unobservable inputs were used to determine fair value:
PREFERRED SECURITIES
--------------------
TOTAL INVESTMENTS BANKING
----------------- --------------------
BALANCE AS OF 11/30/09 ............................ $24,750 $24,750
Accrued discounts/premiums ........................ -- --
Realized gain/(loss) .............................. -- --
Change in unrealized appreciation/(depreciation) .. (4,842) (4,842)
Net purchases/(sales) ............................. -- --
Transfer in and/or out of Level 3 ................. -- --
------- -------
BALANCE AS OF 11/30/10 ............................ $19,908 $19,908
As of November 30, 2010, total change in unrealized gain/(loss) on Level 3
securities still held at year-end and included in the change in net assets was
$(4,842). Total unrealized gain/(loss) for all securities (including Level 1 and
Level 2) can be found on the accompanying Statement of Operations.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are
recorded as of the trade date. Realized gains and losses from securities sold
are recorded on the specific identified cost basis. Dividend income is recorded
on ex-dividend dates. Interest income is recorded on the accrual basis. The Fund
also amortizes premiums and accretes discounts on fixed income securities using
the effective yield method.
OPTIONS: Purchases of options are recorded as an investment, the value of
which is marked-to-market at each valuation date. When the Fund enters into a
closing sale transaction, the Fund will record a gain or loss depending on the
difference between the purchase and sale price.
When the Fund writes an option, an amount equal to the premium received by
the Fund is recorded as a liability, the value of which is marked-to-market at
each valuation date. When a written option expires, the Fund realizes a gain
equal to the amount of the premium originally received. When the Fund enters
into a closing purchase transaction, the Fund realizes a gain (or loss if the
cost of the closing purchase transaction exceeds the premium received when the
option was written) without regard to any unrealized gain or loss on the
underlying security, and the liability related to such option is eliminated.
When a call option is exercised, the Fund realizes a gain or loss from the sale
of the underlying security and the proceeds from such sale are increased by the
amount of the premium originally received. When a put option is exercised, the
amount of the premium originally received will reduce the cost of the security
which the Fund purchased upon exercise.
REPURCHASE AGREEMENTS: The Fund may engage in repurchase agreement
transactions. The Fund's investment adviser reviews and approves the eligibility
of the banks and dealers with which the Fund may enter into repurchase agreement
transactions. The value of the collateral underlying such transactions is at
least equal at all times to the total amount of the repurchase obligations,
including interest. The Fund maintains possession of the collateral through its
custodian and, in the event of counterparty default, the Fund has the right to
use the collateral to offset losses incurred. There is the possibility of loss
to the Fund in the event the Fund is delayed or prevented from exercising its
rights to dispose of the collateral securities.
25
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company by complying with the requirements under subchapter
M of the Internal Revenue Code of 1986, as amended, applicable to regulated
investment companies and intends to distribute substantially all of its taxable
net investment income to its shareholders. Therefore, no federal income tax
provision is required.
Management has analyzed the Fund's tax positions taken on Federal income
tax returns for all open tax years (November 30, 2010, 2009, 2008 and 2007), and
has concluded that no provision for federal income tax is required in the Fund's
financial statements. The Fund's major tax jurisdictions are federal and
California. The Fund's federal and state income and federal excise tax returns
for tax years for which the applicable statutes of limitations have not expired
are subject to examination by the Internal Revenue Service and state departments
of revenue.
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS: The Fund expects to declare
dividends on a monthly basis to shareholders of Common Stock ("Shareholders").
Distributions to Shareholders are recorded on the ex-dividend date. Any net
realized short-term capital gains will be distributed to Shareholders at least
annually. Any net realized long-term capital gains may be distributed to
Shareholders at least annually or may be retained by the Fund as determined by
the Fund's Board of Directors. Capital gains retained by the Fund are subject to
tax at the capital gains corporate tax rate. Subject to the Fund qualifying as a
regulated investment company, any taxes paid by the Fund on such net realized
long-term capital gains may be used by the Fund's Shareholders as a credit
against their own tax liabilities. The Fund may pay distributions in excess of
the Fund's net investment company taxable income and this excess would be a
tax-free return of capital distributed from the Fund's assets.
Income and capital gain distributions are determined and characterized in
accordance with income tax regulations which may differ from US GAAP. These
differences are primarily due to (1) differing treatments of income and gains on
various investment securities held by the Fund, including timing differences,
(2) the attribution of expenses against certain components of taxable investment
income, and (3) federal regulations requiring proportionate allocation of income
and gains to all classes of shareholders.
Distributions from net realized gains for book purposes may include
short-term capital gains, which are included as ordinary income for tax
purposes, and may exclude amortization of premium on certain fixed income
securities, which are not reflected in ordinary income for tax purposes. The tax
character of distributions paid, including changes in accumulated undeclared
distributions to APS shareholders, during 2010 and 2009 was as follows:
DISTRIBUTIONS PAID IN FISCAL YEAR 2010 DISTRIBUTIONS PAID IN FISCAL YEAR 2009
-------------------------------------- --------------------------------------
ORDINARY LONG-TERM ORDINARY LONG-TERM
INCOME CAPITAL GAINS INCOME CAPITAL GAINS
---------- ------------- ---------- -------------
Common $9,263,572 $0 $7,125,108 $0
Preferred $ 73,485 $0 $ 936,183 $0
26
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
As of November 30, 2010, the components of distributable earnings (i.e.,
ordinary income and capital gain/loss) available to Common Stock Shareholders,
on a tax basis, were as follows:
UNDISTRIBUTED UNDISTRIBUTED NET UNREALIZED
CAPITAL (LOSS) CARRYFORWARD ORDINARY INCOME LONG-TERM GAIN APPRECIATION/(DEPRECIATION)
--------------------------- --------------- -------------- ---------------------------
$(29,782,473) $824,616 $0 $7,120,844
The composition of the Fund's $29,782,473 accumulated realized capital
losses was $851,491, $15,168,592 and $13,762,390 incurred in 2007, 2008 and
2009, respectively. These losses may be carried forward and offset against any
future capital gains through 2015, 2016 and 2017, respectively. During the year
ended November 30, 2010, the Fund utilized $1,223,987, $694,286 and $1,200,020
of capital losses expiring in 2010, 2012 and 2015.
RECLASSIFICATION OF ACCOUNTS: During the year ended November 30, 2010,
reclassifications were made in the Fund's capital accounts to report these
balances on a tax basis, excluding temporary differences, as of November 30,
2010. Additional adjustments may be required in subsequent reporting periods.
These reclassifications have no impact on the net asset value of the Fund. The
calculation of net investment income per share in the financial highlights
excludes these adjustments. Below are the reclassifications:
PAID-IN UNDISTRIBUTED ACCUMULATED NET REALIZED
CAPITAL NET INVESTMENT INCOME GAIN ON INVESTMENTS
------- --------------------- ------------------------
$12,804 $(545,443) $532,639
EXCISE TAX: The Internal Revenue Code of 1986, as amended, imposes a 4%
nondeductible excise tax on the Fund to the extent the Fund does not distribute
by the end of any calendar year at least (1) 98% of the sum of its net
investment income for that year and its capital gains (both long-term and
short-term) for its fiscal year and (2) certain undistributed amounts from
previous years. The Fund is subject to a payment of an estimated $24,000 of
Federal excise taxes attributable to calendar year 2010. The Fund paid $14,798
of Federal excise taxes attributable to calendar year 2009 in March 2010.
ADDITIONAL ACCOUNTING STANDARDS: In January 2010, the Financial Accounting
Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2010-06,
"Improving Disclosures about Fair Value Measurements". ASU No. 2010-06 amends
FASB Accounting Standards Codification Topic 820, Fair Value Measurements and
Disclosures, to require additional disclosures regarding fair value
measurements. Certain disclosures required by ASU No. 2010-06 are effective for
interim and annual reporting periods beginning after December 15, 2009, and
other required disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. Management
has evaluated the impact and has incorporated the disclosures required by ASU
No. 2010-06 in its financial statement disclosures.
27
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. DERIVATIVE INSTRUMENTS
The Fund intends to use derivatives primarily to economically hedge against
risks in the portfolio, namely interest rate risk and credit risk. Historically
the Fund has used options on treasury futures contracts for the purpose of
economically hedging against a significant increase in long-term interest rates.
When the strategy has been employed, the Fund would purchase put options on
treasury futures contracts that would increase in value if long-term interest
rates increased significantly, offsetting some of the related decline in
portfolio asset values. The Fund has also purchased and written call options on
treasury futures contracts to supplement the put option strategy and also to
reduce the overall cost of the interest rate hedge (by earning premiums from the
net sale of call options).
The Fund has the authority to use other derivatives for hedging or to
increase expected return, but has not employed any of these derivatives to-date
and does not anticipate broad use of these derivatives in the near future
(although this may change without advance notice). Other approved derivatives
strategies include: buying and selling credit default swaps, interest rate swaps
and options thereon (swaptions), and options on securities. Accounting policies
for specific derivatives, including the location of these items in the financial
statements, are included in Note 2 as appropriate. No assurance can be given
that such use of derivatives will achieve their desired purposes or, in the case
of hedging, will result in an overall reduction of risk to the Fund.
The Fund did not use any derivatives during the fiscal years ended November
30, 2009 and November 30, 2010.
OPTIONS ON FINANCIAL FUTURES CONTRACTS: When the interest rate hedging
strategy is employed, the Fund intends to use options on financial futures
contracts in much the same way as described above. The risk associated with
purchasing options, and therefore the maximum loss the Fund would incur, is
limited to the purchase price originally paid. The risk in writing a call option
is that the Fund may forego the opportunity for profit if the market price of
the underlying security increases and the option is exercised. The risk in
writing a put option is that the Fund may incur a loss if the market price of
the underlying security decreases and the option is exercised.
4. INVESTMENT ADVISORY FEE, ADMINISTRATION FEE, TRANSFER AGENT FEE, CUSTODIAN
FEE, DIRECTORS' FEES AND CHIEF COMPLIANCE OFFICER FEE
Flaherty & Crumrine Incorporated (the "Adviser") serves as the Fund's
investment adviser. The Fund pays the Adviser a monthly fee at an annual rate of
0.625% of the value of the Fund's average monthly total managed assets up to
$100 million and 0.50% of the Fund's average monthly total managed assets of
$100 million or more.
For purposes of calculating the fees payable to the Adviser, Administrator
and Custodian, the Fund's total managed assets means the total assets of the
Fund (including any assets attributable to the Fund's preferred stock that may
be outstanding or otherwise attributable to the use of leverage) minus the sum
of accrued liabilities (other than debt, if any, representing financial
leverage). For purposes of determining total managed assets, the liquidation
preference of any outstanding preferred shares issued by the Fund is not treated
as a liability.
28
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
BNY Mellon Investment Servicing (US) Inc. ("BNY Mellon") (formerly known as
PNC Global Investment Servicing (U.S.) Inc.) serves as the Fund's Administrator.
As Administrator, BNY Mellon calculates the net asset value of the Fund's shares
attributable to Common Stock and generally assists in all aspects of the Fund's
administration and operation. As compensation for BNY Mellon's services as
Administrator, the Fund pays BNY Mellon a monthly fee at an annual rate of 0.10%
of the first $200 million of the Fund's average weekly total managed assets,
0.04% of the next $300 million of the Fund's average weekly total managed
assets, 0.03% of the next $500 million of the Fund's average weekly total
managed assets and 0.02% of the Fund's average weekly total managed assets above
$1 billion.
BNY Mellon also serves as the Fund's Common Stock dividend-paying agent and
registrar (Transfer Agent). As compensation for BNY Mellon's services, the Fund
pays BNY Mellon a fee at an annual rate of 0.02% of the first $150 million of
the Fund's average weekly net assets attributable to Common Stock, 0.0075% of
the next $350 million of the Fund's average weekly net assets attributable to
Common Stock, and 0.0025% of the Fund's average weekly net assets attributable
to Common Stock above $500 million, plus certain out of pocket expenses. For the
purpose of calculating such fee, the Fund's average weekly net assets
attributable to Common Stock are deemed to be the average weekly value of the
Fund's total assets minus the sum of the Fund's liabilities. For this
calculation, the Fund's liabilities are deemed to include the aggregate
liquidation preference of any outstanding preferred shares and the loan
principal balance.
PFPC Trust Company ("PFPC Trust"), a member of BNY Mellon, serves as the
Fund's Custodian. As compensation for PFPC Trust's services as custodian, the
Fund pays PFPC Trust a monthly fee at the annual rate of 0.01% of the first $200
million of the Fund's average weekly total managed assets, 0.008% of the next
$300 million of the Fund's average weekly total managed assets, 0.006% of the
next $500 million of the Fund's average weekly total managed assets and 0.005%
of the Fund's average weekly total managed assets above $1 billion.
The Fund currently pays each Director who is not a director, officer or
employee of the Adviser a fee of $9,000 per annum, plus $750 for each in-person
meeting of the Board of Directors or Audit Committee, $500 for each in-person
meeting of the Nominating Committee, and $250 for each telephone meeting. The
Audit Committee Chairman receives an additional annual fee of $3,000. The Fund
also reimburses all Directors for travel and out-of-pocket expenses incurred in
connection with such meetings.
The Fund currently pays the Adviser a fee of $37,500 per annum for Chief
Compliance Officer services and reimburses out-of-pocket expenses incurred in
connection with providing services in this role.
5. PURCHASES AND SALES OF SECURITIES
For the year ended November 30, 2010, the cost of purchases and proceeds
from sales of securities excluding short-term investments, aggregated
$67,030,360 and $55,131,417, respectively.
At November 30, 2010, the aggregate cost of securities for federal income
tax purposes was $162,891,392, the aggregate gross unrealized appreciation for
all securities in which there is an excess of value over tax cost was
$22,567,484 and the aggregate gross unrealized depreciation for all securities
in which there is an excess of tax cost over value was $15,446,640.
29
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. COMMON STOCK
At November 30, 2010, 240,000,000 shares of $0.01 par value Common Stock
were authorized.
Common Stock transactions were as follows:
YEAR ENDED YEAR ENDED
11/30/10 11/30/09
----------------- -----------------
SHARES AMOUNT SHARES AMOUNT
------ -------- ------ --------
Shares issued under the Dividend Reinvestment
and Cash Purchase Plan ................... 86,726 $817,031 73,567 $375,985
------ -------- ------ --------
7. AUCTION PREFERRED STOCK (APS)
The Fund's Articles of Incorporation authorize the issuance of up to
10,000,000 shares of $0.01 par value preferred stock. Prior to August 4, 2009,
the Fund had preferred stock issued in the form of APS. The APS was senior to
the Common Stock and resulted in the financial leveraging of the Common Stock.
As of August 4, 2009, the Fund redeemed and cancelled the last remaining shares
of APS and does not currently have any issued and outstanding shares of
preferred stock. Although the APS was redeemed, certain additional distributions
were owed to previous holders and were paid in December, 2009.
The Fund repurchased APS shares in negotiated private transactions as
detailed in the table below. The gain resulting from both purchases was $1.6
million.
TRADE DATE SETTLEMENT DATE $ AMOUNT OF APS
---------- ----------------- ---------------
November 10, 2008 November 14, 2008 $4,500,000
November 10, 2008 November 18, 2008 $3,500,000
The Fund redeemed APS shares as detailed in the table below. Shares were
redeemed at a redemption price equal to the liquidation preference of $100,000
per share, plus the amount of accumulated but unpaid dividends for each
redemption date, respectively. The Fund utilized proceeds from its debt facility
(See Note 8) for the last redemption. After these redemptions, borrowings from
its debt facility were the Fund's sole source of leverage.
REDEMPTION DATE $ AMOUNT OF APS
--------------- ---------------
October 14, 2008 $10,000,000
November 20, 2008 2,400,000*
March 10, 2009 13,000,000*
August 4, 2009 36,600,000
* Shares were redeemed on the dates reflected; however, from the Fund's
perspective, the November 20th redemption was effective as of October 24,
2008 and the March 10th redemption was effective as of February 24, 2009.
In both cases, the earlier effective date was due to the unconditional
deposit of funds with the paying agent.
30
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. COMMITTED FINANCING AGREEMENT
The Fund entered into a committed financing agreement ("Financing
Agreement") on June 26, 2009 which allowed the Fund to borrow up to an initial
limit of $36.6 million on a secured basis. The primary use of the initial
proceeds was to redeem the outstanding shares of APS (See Note 7), although, the
Fund will use the borrowing facility in the normal course of business as
financial leverage. Such leveraging tends to magnify both the risks and
opportunities to Shareholders. The Financing Agreement has been amended from
time to time to allow for changes in the committed amount. As of November 30,
2010, the committed amount, and amount borrowed under the Financing Agreement
was $55.2 million.
The lender charges an annualized rate of 1.00% on the undrawn (committed)
balance, and three-month LIBOR (reset quarterly) plus 1.10% on the drawn
(borrowed) balance. Effective January 1, 2011 (subsequent to the reporting
period), the interest rates charged by the lender will be reduced. The
annualized rate on the undrawn balance will be 0.80% and the rate on the drawn
balance will be three-month LIBOR (reset quarterly) plus 0.95%. For the year
ended November 30, 2010, the daily weighted average annualized interest rate on
the drawn balance was 1.443% and the average daily loan balance was $53,134,521.
The Fund paid the lender an arrangement fee (at the origination of the facility)
equal to 0.50% of the committed amount of $36.6 million. The arrangement fee was
amortized to expense over a period of approximately eighteen months. LIBOR rates
may vary in a manner unrelated to the income received on the Fund's assets,
which could have either a beneficial or detrimental impact on net investment
income and gains available to Shareholders.
The Fund is required to meet certain asset coverage requirements under the
Financing Agreement and under the 1940 Act. In accordance with the asset
coverage requirements, at least two-thirds of the Fund's assets are expected to
be pledged as collateral assuming the full committed amount is drawn. Securities
pledged as collateral are identified in the portfolio of investments. If the
Fund fails to meet these requirements, or maintain other financial covenants
required under the Financing Agreement, the Fund may be required to repay
immediately, in part or in full, the amount borrowed under the Financing
Agreement. Additionally, failure to meet the foregoing requirements or covenants
could restrict the Fund's ability to pay dividends to Shareholders and could
necessitate sales of portfolio securities at inopportune times. The Financing
Agreement has no stated maturity, but may be terminated by either party without
cause with six months' advance notice.
9. PORTFOLIO INVESTMENTS, CONCENTRATION AND INVESTMENT QUALITY
The Fund invests primarily in a diversified portfolio of preferred
securities. This includes traditional preferred stocks eligible for the
inter-corporate dividends received deduction ("DRD") and fully taxable preferred
securities. Under normal market conditions, at least 80% of the value of the
Fund's net assets will be invested in preferred securities. Also, under normal
market conditions, the Fund invests at least 25% of its total assets in
securities of issuers in each of the utilities industry and financial services
sector. For purposes of the financial services sector concentration policy, a
company is within the financial services sector if it derives at least 50% of
its revenue from providing financial services. 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.
31
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The Fund may invest up to 25% of its assets at the time of purchase in
securities rated below investment grade. These securities must be rated at least
either "Ba3" by Moody's Investors Service, Inc. or "BB-" by Standard & Poor's
or, if unrated, judged to be comparable in quality by the Adviser, in any case,
at the time of purchase. However, these securities must be issued by an issuer
having a class of senior debt rated investment grade outstanding.
The Fund may invest up to 15% of its assets in common stocks and, under
normal market conditions, up to 20% of its assets in debt securities. Certain of
its investments in hybrid, i.e., fully taxable, preferred securities will be
subject to the foregoing 20% limitation to the extent that, in the opinion of
the Adviser, such investments are deemed to be debt-like in key characteristics.
Typically, a security will not be considered debt-like (a) if an issuer can
defer payment of income for eighteen months or more without triggering an event
of default and (b) if such issue is a junior and fully subordinated liability of
an issuer or its ultimate guarantor.
In addition to foreign money market securities, the Fund may invest up to
30% of its total assets in the securities of companies organized or having their
principal place of business outside the United States. All foreign securities
held by the Fund will be denominated in U.S. dollars.
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. The Fund may also enter into transactions, in accordance with its
investment policies, involving short sales of securities and purchases of
securities on margin. Such transactions may expose the Fund to credit and market
valuation risk greater than that associated with regular trade settlement
procedures.
10. SECURITIES LENDING
The Fund may lend up to 15% of its total assets (including the value of the
loan collateral) to certain qualified brokers in order to earn additional
income. The Fund receives compensation in the form of fees or interest earned on
the investment of any cash collateral received. The Fund also continues to
receive interest and dividends on the securities loaned. The Fund receives
collateral in the form of cash or securities with a market value at least equal
to the market value of the securities on loan, including accrued interest. In
the event of default or bankruptcy by the borrower, the Fund could experience
delays and costs in recovering the loaned securities or in gaining access to the
collateral. The Fund has the right under the lending agreement to recover the
securities from the borrower on demand. As of November 30, 2010 there were no
securities on loan by the Fund.
11. SUBSEQUENT EVENTS
Management has evaluated the impact of all subsequent events on the Fund
through the date the financial statements were issued, and has determined that
there were no subsequent events requiring recognition or disclosure in the
financial statements.
32
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
We have audited the accompanying statement of assets and liabilities of
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated, including
the portfolio of investments, as of November 30, 2010, and the related statement
of operations for the year then ended, the statements of changes in net assets
for each of the years in the two-year period then ended, the statement of cash
flows for the year then ended, and the financial highlights for each of the
years in the five-year period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. Our procedures included
confirmation of securities owned as of November 30, 2010 by correspondence with
the custodian and brokers, or by other appropriate auditing procedures where
replies from brokers were not received. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated as of
November 30, 2010, the results of its operations and its cash flows for the year
then ended, the changes in its net assets for each of the years in the two-year
period then ended, and the financial highlights for each of the years in the
five-year period then ended, in conformity with U.S. generally accepted
accounting principles.
(KPMG LLP)
Boston, Massachusetts
January 24, 2011
33
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED)
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
Under the Fund's Dividend Reinvestment and Cash Purchase Plan (the "Plan"),
a shareholder whose Common Stock is registered in his or her own name will have
all distributions reinvested automatically by BNY Mellon 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, BNY Mellon will buy shares of the Fund's Common
Stock in the open market, on the New York Stock Exchange ("NYSE") or elsewhere,
on or shortly after the payment date of the dividend or distribution and
continuing until the ex-dividend date of the Fund's next distribution to holders
of the Common Stock or until it has expended for such purchases all of the cash
that would otherwise be payable to the participants. The number of purchased
shares that will then be credited to the participants' accounts will be based on
the average per share purchase price of the shares so purchased, including
brokerage commissions. If BNY Mellon 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, BNY Mellon 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 BNY
Mellon's open market purchases in connection with the reinvestment of dividends
or capital gains distributions. For the year ended November 30, 2010, $565 in
brokerage commissions were incurred.
The automatic reinvestment of dividends and capital gains distributions
will not relieve Plan participants of any income tax that may be payable on the
dividends or capital gains distributions. A participant in the Plan will be
treated for Federal income tax purposes as having received, on the dividend
payment date, a dividend or distribution in an amount equal to the cash that the
participant could have received instead of shares.
34
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
In addition to acquiring shares of Common Stock through the reinvestment of
cash dividends and distributions, a shareholder may invest any further amounts
from $100 to $3,000 semi-annually at the then current market price in shares
purchased through the Plan. Such semi-annual investments are subject to any
brokerage commission charges incurred by BNY Mellon under the Plan.
A shareholder whose Common Stock is registered in his or her own name may
terminate participation in the Plan at any time by notifying BNY Mellon in
writing, by completing the form on the back of the Plan account statement and
forwarding it to BNY Mellon, or by calling BNY Mellon directly. A termination
will be effective immediately if notice is received by BNY Mellon 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, BNY Mellon 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 BNY Mellon at
1-866-351-7446.
PROXY VOTING POLICIES AND PROXY VOTING RECORD ON FORM N-PX
The Fund files Form N-PX with its complete proxy voting record for the 12
months ended June 30th no later than August 31st of each year. The Fund filed
its latest Form N-PX with the Securities and Exchange Commission ("SEC") on
August 23, 2010. This filing, as well as the Fund's proxy voting policies and
procedures, are available (i) without charge, upon request, by calling the
Fund's transfer agent at 1-866-351-7446 and (ii) on the SEC's website at
www.sec.gov. In addition, the Fund's proxy voting policies and procedures are
available on the Fund's website at www.preferredincome.com.
PORTFOLIO SCHEDULE ON FORM N-Q
The Fund files a complete schedule of portfolio holdings with the SEC for
the first and third fiscal quarters on Form N-Q, the latest of which was filed
for the quarter ended August 31, 2010. The Fund's Form N-Q is available on the
SEC's website at WWW.SEC.GOV or may be viewed and obtained from the SEC's Public
Reference Room in Washington D.C. Information on the operation of the Public
Reference Section may be obtained by calling 1-800-SEC-0330.
PORTFOLIO MANAGEMENT TEAM
In managing the day-to-day operations of the Fund, the Adviser relies on
the expertise of its team of money management professionals, consisting of
Messrs. Crumrine, Ettinger, Stone and Chadwick. The professional backgrounds of
each member of the management team are included in the "Information about Fund
Directors and Officers" section of this report.
35
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
SUPPLEMENTARY TAX INFORMATION
Distributions to Common Stock Shareholders are characterized as follows for
purposes of Federal income taxes (as a percentage of total distributions):
INDIVIDUAL SHAREHOLDER CORPORATE SHAREHOLDER
---------------------- ---------------------
ORDINARY ORDINARY
QDI INCOME DRD INCOME
----- -------- ----- ---------
Fiscal Year 2010 48.07% 51.93% 20.87% 79.13%
Calendar Year 2010 48.52% 51.48% 19.58% 80.42%
Qualified Dividend Income ("QDI") distributions are taxable at a maximum
15% personal tax rate.
INFORMATION ABOUT FUND DIRECTORS AND OFFICERS
The business and affairs of the Fund are managed under the direction of the
Fund's Board of Directors. Information pertaining to the Directors and officers
of the Fund is set forth below.
PRINCIPAL NUMBER OF FUNDS
TERM OF OFFICE OCCUPATION(S) IN FUND COMPLEX
NAME, ADDRESS, POSITION(S) AND LENGTH OF DURING PAST OVERSEEN OTHER DIRECTORSHIPS
AND AGE HELD WITH FUND TIME SERVED* FIVE YEARS BY DIRECTOR HELD BY DIRECTOR**
-------------------------- -------------- ------------------ ---------------------------- --------------- --------------------
NON-INTERESTED
DIRECTORS:
DAVID GALE Director Class I Director President of Delta 4
Delta Dividend Group, Inc. since Dividend Group, Inc.
220 Montgomery Street January 1997 (investments)
Suite 426
San Francisco, CA 94104
Age: 61
MORGAN GUST Director Class III Director Owner and operator of 4 CoBiz, Financial,
301 E. Colorado Boulevard since various entities engaged in Inc.
Suite 720 February 1992 agriculture and real estate; (financial services)
Pasadena, CA 91101 Former President of Giant
Age: 63 Industries, Inc. (petroleum
refining and marketing) from
March 2002 through June 2007
----------
* The Fund's Board of Directors is divided into three classes, each class
having a term of three years. Each year the term of office of one class
expires and the successor or successors elected to such class serve for a
three year term. The three year term for each class expires as follows:
CLASS I DIRECTOR - three year term expires at the Fund's 2012 Annual
Meeting of Shareholders; director may continue in office until his
successor is duly elected and qualified.
CLASS II DIRECTORS - three year term expires at the Fund's 2013 Annual
Meeting of Shareholders; directors may continue in office until their
successors are duly elected and qualified.
CLASS III DIRECTORS - three year term expires at the Fund's 2011
Annual Meeting of Shareholders; directors may continue in office until
their successors are duly elected and qualified.
** Each Director also serves as a Director for Flaherty & Crumrine Preferred
Income Fund, Flaherty & Crumrine/Claymore Preferred Securities Income Fund,
and Flaherty & Crumrine/Claymore Total Return Fund.
36
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
PRINCIPAL NUMBER OF FUNDS
TERM OF OFFICE OCCUPATION(S) IN FUND COMPLEX
NAME, ADDRESS, POSITION(S) AND LENGTH OF DURING PAST OVERSEEN OTHER DIRECTORSHIPS
AND AGE HELD WITH FUND TIME SERVED* FIVE YEARS BY DIRECTOR HELD BY DIRECTOR**
-------------------------- -------------- ------------------ ---------------------------- --------------- --------------------
NON-INTERESTED
DIRECTORS:
KAREN H. HOGAN+ Director Class III Director Active Committee Member 4
301 E. Colorado Boulevard since and Volunteer to several
Suite 720 April 2005 non-profit organizations;
Pasadena, CA 91101 from September 1985 to
Age: 49 January 1997, Senior Vice
President of Preferred Stock
Origination at Lehman
Brothers and Previously,
Vice President of New
Product Development
ROBERT F. WULF Director Class II Director Financial Consultant; 4
P.O. Box 753 and Audit since Trustee, University of
Neskowin, OR 97149 Committee February 1992 Oregon Foundation;
Age: 73 Chairman Trustee, San Francisco
Theological Seminary
INTERESTED
DIRECTOR:
DONALD F. CRUMRINE++ Director, Class II Director Chairman of the Board 4
301 E. Colorado Boulevard Chairman of since and Director of Flaherty &
Suite 720 the Board and February 1992 Crumrine Incorporated
Pasadena, CA 91101 Chief
Age: 63 Executive
Officer
----------
* The Fund's Board of Directors is divided into three classes, each class
having a term of three years. Each year the term of office of one class
expires and the successor or successors elected to such class serve for a
three year term. The three year term for each class expires as follows:
CLASS I DIRECTOR - three year term expires at the Fund's 2012 Annual
Meeting of Shareholders; director may continue in office until his
successor is duly elected and qualified.
CLASS II DIRECTORS - three year term expires at the Fund's 2013 Annual
Meeting of Shareholders; directors may continue in office until their
successors are duly elected and qualified.
CLASS III DIRECTORS - three year term expires at the Fund's 2011
Annual Meeting of Shareholders; directors may continue in office until
their successors are duly elected and qualified.
** Each Director also serves as a Director for Flaherty & Crumrine Preferred
Income Fund, Flaherty & Crumrine/Claymore Preferred Securities Income Fund,
and Flaherty & Crumrine/Claymore Total Return Fund.
+ As a Director, until August 4, 2009, represented holders of shares of the
Fund's Auction Preferred Stock.
++ "Interested person" of the Fund as defined in the 1940 Act. Mr. Crumrine is
considered an "interested person" because of his affiliation with Flaherty
& Crumrine Incorporated, which acts as the Fund's investment adviser.
37
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
PRINCIPAL
TERM OF OFFICE OCCUPATION(S)
NAME, ADDRESS, POSITION(S) AND LENGTH OF DURING PAST
AND AGE HELD WITH FUND TIME SERVED FIVE YEARS
------------------------- -------------------- -------------- ------------------------------------
OFFICERS:
ROBERT M. ETTINGER President Since President and Director of Flaherty &
301 E. Colorado Boulevard October 2002 Crumrine Incorporated
Suite 720
Pasadena, CA 91101
Age: 52
R. ERIC CHADWICK Chief Financial Since Director of Flaherty & Crumrine
301 E. Colorado Boulevard Officer, Vice July 2004 Incorporated since June 2006;
Suite 720 President and Vice President of Flaherty &
Pasadena, CA 91101 Treasurer Crumrine Incorporated
Age: 35
CHAD C. CONWELL Chief Compliance Since Chief Compliance Officer of
301 E. Colorado Boulevard Officer, Vice July 2005 Flaherty & Crumrine Incorporated
Suite 720 President and since September 2005; Vice
Pasadena, CA 91101 Secretary President of Flaherty & Crumrine
Age: 38 Incorporated since July 2005
BRADFORD S. STONE Vice President Since Director of Flaherty & Crumrine
47 Maple Street and Assistant July 2003 Incorporated since June 2006;
Suite 403 Treasurer Vice President of Flaherty &
Summit, NJ 07901 Crumrine Incorporated
Age: 51
LAURIE C. LODOLO Assistant Compliance Since Assistant Compliance Officer and
301 E. Colorado Boulevard Officer, Assistant July 2004 Secretary of Flaherty & Crumrine
Suite 720 Treasurer and Incorporated
Pasadena, CA 91101 Assistant Secretary
Age: 47
LINDA M. PUCHALSKI Assistant Since Administrator of Flaherty & Crumrine
301 E. Colorado Boulevard Treasurer August 2010 Incorporated
Suite 720
Pasadena, CA 91101
Age: 54
38
[This page intentionally left blank]
(FLAHERTY & CRUMRINE PREFERRED INCOME OPPORTUNITY FUND LOGO)
Annual
Report
November 30, 2010
www.preferredincome.com
DIRECTORS
Donald F. Crumrine, CFA
Chairman of the Board
David Gale
Morgan Gust
Karen H. Hogan
Robert F. Wulf, CFA
OFFICERS
Donald F. Crumrine, CFA
Chief Executive Officer
Robert M. Ettinger, CFA
President
R. Eric Chadwick, CFA
Chief Financial Officer,
Vice President and Treasurer
Chad C. Conwell
Chief Compliance Officer,
Vice President and Secretary
Bradford S. Stone
Vice President and
Assistant Treasurer
Laurie C. Lodolo
Assistant Compliance Officer,
Assistant Treasurer and
Assistant Secretary
Linda M. Puchalski
Assistant Treasurer
INVESTMENT ADVISER
Flaherty & Crumrine Incorporated
e-mail: flaherty@pfdincome.com
QUESTIONS CONCERNING YOUR SHARES OF FLAHERTY & CRUMRINE PREFERRED INCOME
OPPORTUNITY 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 --
BNY Mellon Shareowner Services
P.O. Box 358035
Pittsburgh, PA 15252-8035
1-866-351-7446
THIS REPORT IS SENT TO SHAREHOLDERS OF FLAHERTY & CRUMRINE PREFERRED INCOME
OPPORTUNITY 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.
ITEM 2. CODE OF ETHICS.
(a) The registrant, as of the end of the period covered by this report,
has adopted a code of ethics that applies to the registrant's
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions, regardless of whether these individuals are employed by the
registrant or a third party.
(c) There have been no amendments, during the period covered by this
report, to a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are
employed by the registrant or a third party, and that relates to any
element of the code of ethics description.
(d) The registrant has not granted any waivers, including an implicit
waiver, from a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are
employed by the registrant or a third party, that relates to one or
more of the items set forth in paragraph (b) of this item's
instructions.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
As of the end of the period covered by the report, the registrant's board of
directors has determined that David Gale, Karen H. Hogan and Robert F. Wulf are
each qualified to serve as an audit committee financial expert serving on its
audit committee and that they all are "independent," as defined by the
Securities and Exchange Commission.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
AUDIT FEES
(a) The aggregate fees billed for each of the last two fiscal years for
professional services rendered by the principal accountant for the audit of
the registrant's annual financial statements or services that are normally
provided by the accountant in connection with statutory and regulatory
filings or engagements for those fiscal years are $44,000 for 2010 and
$44,000 for 2009.
AUDIT-RELATED FEES
(b) The aggregate fees billed in each of the last two fiscal years for
assurance and related services by the principal accountant that are
reasonably related to the performance of the audit of the
registrant's financial statements and are not reported under paragraph (a)
of this Item are $0 for 2010 and $0 for 2009.
TAX FEES
(c) The aggregate fees billed in each of the last two fiscal years for
professional services rendered by the principal accountant for tax
compliance, tax advice, and tax planning are $8,100 for 2010 and $8,100 for
2009.
ALL OTHER FEES
(d) The aggregate fees billed in each of the last two fiscal years for products
and services provided by the principal accountant, other than the services
reported in paragraphs (a) through (c) of this Item are $0 for 2010 and
$8,600 for 2009. These services consist of the principal accountant
providing a "Quarterly Agreed-Upon-Procedures Report on Articles
Supplementary". These Agreed-Upon-Procedures ("AUP") are requirements
arising from the Articles Supplementary creating the Fund's preferred
stock. Specifically, the credit rating agencies require such AUP be
undertaken in order to maintain the preferred stock's rating.
(e)(1) The Fund's Audit Committee Charter states that the Audit Committee shall
have the duty and power to pre-approve all audit and non-audit services to
be provided by the auditors to the Fund, and all non-audit services to be
provided by the auditors to the Fund's investment adviser and any service
providers controlling, controlled by or under common control with the
Fund's investment adviser that provide ongoing services to the Fund, if the
engagement relates directly to the operations and financial reporting of
the Fund.
(e)(2) The percentage of services described in each of paragraphs (b) through
(d) of this Item that were approved by the audit committee pursuant to
paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X are as follows:
(b) 0%
(c) 0%
(d) 0%
(f) The percentage of hours expended on the principal accountant's engagement
to audit the registrant's financial statements for the most recent fiscal
year that were attributed to work performed by persons other than the
principal accountant's full-time, permanent employees was 0%.
(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's
investment adviser (not including any sub-adviser whose role is primarily
portfolio management and is subcontracted with or overseen by another
investment adviser), and any entity controlling, controlled by, or under
common control with the adviser that provides ongoing services to the
registrant for each of the last two fiscal years of the registrant was $0
for 2010 and $0 for 2009.
(h) Not applicable.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
(a) The registrant has a separately designated audit committee consisting of
all the independent directors of the registrant. The members of the audit
committee are: David Gale, Morgan Gust, Karen H. Hogan, and Robert F. Wulf.
ITEM 6. INVESTMENTS.
(a) Schedule of Investments in securities of unaffiliated issuers as of the
close of the reporting period is included as part of the report to
shareholders filed under Item 1 of this form.
(b) Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Proxy Voting Policies are attached herewith.
ADVISER PROXY VOTING POLICIES AND PROCEDURES
Flaherty & Crumrine Incorporated ("F&C") acts as discretionary investment
adviser for various clients, including the following six pooled investment
vehicles (the "Funds"):
As adviser to the "U.S. Funds" Flaherty & Crumrine Preferred Income Fund
Flaherty & Crumrine Preferred Income Opportunity Fund
Flaherty & Crumrine/Claymore Preferred Securities Income Fund
Flaherty & Crumrine/Claymore Total Return Fund
As sub-adviser
to the "Canadian Fund" Flaherty & Crumrine Investment Grade Fixed Income Fund
F&C's authority to vote proxies for its clients is established through the
delegation of discretionary authority under its investment advisory contracts
and the U.S. Funds have adopted these policies and procedures for themselves
PURPOSE
These policies and procedures are designed to satisfy F&C's duties of care and
loyalty to its clients with respect to monitoring corporate events and
exercising proxy authority in the best interests of such clients.
In connection with this objective, these policies and procedures are designed to
deal with potential complexities which may arise in cases where F&C's interests
conflict or appear to conflict with the interests of its clients.
These policies and procedures are also designed to communicate with clients the
methods and rationale whereby F&C exercises proxy voting authority.
This document is available to any client or Fund shareholder upon request and
F&C will make available to such clients and Fund shareholders the record of
F&C's votes promptly upon request and to the extent required by Federal law and
regulations.
FUNDAMENTAL STANDARD
F&C will be guided by the principle that, in those cases where it has proxy
voting authority, it will vote proxies, and take such other corporate actions,
consistent with the interest of its clients in a manner free of conflicts of
interest with the objective of client wealth maximization.
GENERAL
F&C has divided its discussion in this document into two major categories:
voting with respect to common stock and voting with respect to senior equity,
e.g., preferred stock and similar securities. In those events where F&C may have
to take action with respect to debt, such as in the case of amendments of
covenants or in the case of default, bankruptcy, reorganization, etc., F&C will
apply the same principles as would apply to common or preferred stock, MUTATIS
MUTANDIS.
These policies and procedures apply only where the client has granted
discretionary authority with respect to proxy voting. Where F&C does not have
authority, it will keep appropriate written records evidencing that such
discretionary authority has not been granted.
F&C may choose not to keep written copies of proxy materials that are subject to
SEC regulation and maintained in the SEC's EDGAR database. In other instances,
F&C will keep appropriate written records in its files or in reasonably
accessible storage.
Similarly, F&C will keep in its files, or reasonably accessible storage, work
papers and other materials that were significant to F&C in making a decision how
to vote.
For purposes of decision making, F&C will assume that each ballot for which it
casts votes is the only security of an issuer held by the client. Thus, when
casting votes where F&C may have discretionary authority with regard to several
different securities of the same issuer, it may vote securities "in favor" for
those securities or classes where F&C has determined the matter in question to
be beneficial while, at the same time, voting "against" for those securities or
classes where F&C has determined the matter to be adverse. Such cases
occasionally arise, for example, in those instances where a vote is required by
both common and preferred shareholders, voting as separate classes, for a change
in the terms regarding preferred stock issuance.
F&C will reach its voting decisions independently, after appropriate
investigation. It does not generally intend to delegate its decision making or
to rely on the recommendations of any third party, although it may take such
recommendations into consideration. F&C may consult with such other experts,
such as CPA's, investment bankers, attorneys, etc., as it regards necessary to
help it reach informed decisions.
Absent good reason to the contrary, F&C will generally give substantial weight
to management recommendations regarding voting. This is based on the view that
management is usually in the best position to know which corporate actions are
in the best interests of common shareholders as a whole.
With regard to those shareholder-originated proposals which are typically
described as "social, environmental, and corporate responsibility" matters, F&C
will typically give weight to management's recommendations and vote against such
shareholder proposals, particularly if the adoption of such proposals would
bring about burdens or costs not borne by those of the issuer's competitors.
In cases where the voting of proxies would not justify the time and costs
involved, F&C may refrain from voting. From the individual client's perspective,
this would most typically come about in the case of small holdings, such as
might arise in connection with spin-offs or other corporate reorganizations.
From the perspective of F&C's institutional clients, this envisions cases (1) as
more fully described below where preferred and common shareholders vote together
as a class or (2) other similar or analogous instances.
Ultimately, all voting decisions are made on a case-by-case basis, taking
relevant considerations into account.
VOTING OF COMMON STOCK PROXIES
F&C categorizes matters as either routine or non-routine, which definition may
or may not precisely conform to the definitions set forth by securities
exchanges or other bodies categorizing such matters. Routine matters would
include such things as the voting for directors and the ratification of auditors
and most shareholder proposals regarding social, environmental, and corporate
responsibility matters. Absent good reason to the contrary, F&C normally will
vote in favor of management's recommendations on these routine matters.
Non-routine matters might include, without limitation, such things as (1)
amendments to management incentive plans, (2) the authorization of additional
common or preferred stock, (3) initiation or termination of barriers to takeover
or acquisition, (4) mergers or acquisitions, (5) changes in the state of
incorporation, (6) corporate reorganizations, and (7) "contested" director
slates. In non-routine matters, F&C, as a matter of policy, will attempt to be
generally familiar with the questions at issue. This will include, without
limitation, studying news in the popular press, regulatory filings, and
competing proxy solicitation materials, if any. Non-routine matters will be
voted on a case-by-case basis, given the complexity of many of these issues.
VOTING OF PREFERRED STOCK PROXIES
Preferred stock, which is defined to include any form of equity senior to common
stock, generally has voting rights only in the event that the issuer has not
made timely payments of income and principal to shareholders or in the event
that a corporation desires to effectuate some change in its articles of
incorporation which might modify the rights of preferred stockholders. These are
non-routine in both form and substance.
In the case of non-routine matters having to do with the modification of the
rights or protections accorded preferred stock shareholders, F&C will attempt,
wherever possible, to assess the costs and benefits of such modifications and
will vote in favor of such modifications only if they are in the bests interests
of preferred shareholders or if the issuer has offered sufficient compensation
to preferred stock shareholders to offset the reasonably foreseeable adverse
consequences of such modifications. A similar type of analysis would be made in
the case where preferred shares, as a class, are entitled to vote on a merger or
other substantial transaction.
In the case of the election of directors when timely payments to preferred
shareholders have not been made ("contingent voting"), F&C will cast its votes
on a case-by-case basis after investigation of the qualifications and
independence of the persons standing for election.
Routine matters regarding preferred stock are the exception, rather than the
rule, and typically arise when the preferred and common shareholders vote
together as a class on such matters as election of directors. F&C will vote on a
case-by-case basis, reflecting the principles set forth elsewhere in this
document. However, in those instances (1) where the common shares of an issuer
are held by a parent company and (2) where, because of that, the election
outcome is not in doubt, F&C does not intend to vote such proxies since the time
and costs would outweigh the benefits.
ACTUAL AND APPARENT CONFLICTS OF INTEREST
Potential conflicts of interest between F&C and F&C's clients may arise when
F&C's relationships with an issuer or with a related third party conflict or
appear to conflict with the best interests of F&C's clients.
F&C will indicate in its voting records available to clients whether or not a
material conflict exists or appears to exist. In addition, F&C will communicate
with the client (which means the independent Directors or Director(s) they may
so designate in the case of the U.S. Funds and the investment adviser in the
case of the Canadian Funds) in instances when a material conflict of interest
may be apparent. F&C must describe the conflict to the client and state F&C's
voting recommendation and the basis therefor. If the client considers there to
be a reasonable basis for the proposed vote notwithstanding the conflict or, in
the case of the Funds, that the recommendation was not affected by the conflict
(without considering the merits of the proposal), F&C will vote in accordance
with the recommendation it had made to the client.
In all such instances, F&C will keep reasonable documentation supporting its
voting decisions and/or recommendations to clients.
AMENDMENT OF THE POLICIES AND PROCEDURES
These policies and procedures may be modified at any time by action of the Board
of Directors of F&C but will not become effective, in the case of the U.S.
Funds, unless they are approved by majority vote of the non-interested directors
of the U.S. Funds. Any such modifications will be sent to F&C's clients by mail
and/or other electronic means in a timely manner. These policies and procedures,
and any amendments hereto, will be posted on the U.S. Funds' websites and will
be disclosed in reports to shareholders as required by law.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
The following paragraphs provide certain information with respect to the
portfolio managers of the Fund and the material conflicts of interest that may
arise in connection with their management of the investments of the Fund, on the
one hand, and the investments of other client accounts for which they have
responsibility, on the other hand. Certain other potential conflicts of interest
with respect to personal trading and proxy voting are discussed above under
"Item 2 - Codes of Ethics" and "Item 7 - Proxy Voting Policies."
(A)(1) PORTFOLIO MANAGERS
R. Eric Chadwick, Donald F. Crumrine, Robert M. Ettinger and Bradford S. Stone
jointly serve as the Portfolio Managers of the Fund. Additional biographical
information about the portfolio managers is available in the Annual Report
included in Response to Item 1 above.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS
The tables below illustrate other accounts where each of the above-mentioned
four portfolio managers has significant day-to-day management responsibilities
as of November 30, 2010:
# OF ACCOUNTS
NAME OF PORTFOLIO TOTAL MANAGED FOR WHICH
MANAGER OR # OF ACCOUNTS TOTAL ASSETS ADVISORY FEE IS
TEAM MEMBER TYPE OF ACCOUNTS MANAGED (MM) BASED ON PERFORMANCE
----------------------- --------------------------------- ------------- ------------ --------------------
1. Donald F. Crumrine Other Registered Investment 3 1,446 0
Companies:
Other Pooled Investment Vehicles: 1 194 0
Other Accounts: 12 2,155 0
2. Robert M. Ettinger Other Registered Investment 3 1,446 0
Companies:
Other Pooled Investment Vehicles: 1 194 0
Other Accounts: 12 2,155 0
3. R. Eric Chadwick Other Registered Investment 3 1,446 0
Companies:
Other Pooled Investment Vehicles: 1 194 0
Other Accounts: 12 2,155 0
4. Bradford S. Stone Other Registered Investment 3 1,446 0
Companies:
Other Pooled Investment Vehicles: 1 194 0
Other Accounts: 12 2,155 0
POTENTIAL CONFLICTS OF INTEREST
In addition to the Fund, the Portfolio Managers jointly manage accounts for
three other closed-end funds, one Canadian fund and other institutional clients.
As a result, potential conflicts of interest may arise as follows:
- ALLOCATION OF LIMITED TIME AND ATTENTION. The Portfolio Managers may
devote unequal time and attention to the management of all accounts.
As a result, the Portfolio Managers may not be able to formulate as
complete a strategy or identify equally attractive investment
opportunities for each of those accounts as might be the case if they
were to devote substantially more attention to the management of one
account.
- ALLOCATION OF LIMITED INVESTMENT OPPORTUNITIES. If the Portfolio
Managers identify an investment opportunity that may be suitable for
multiple accounts, the Fund may not be able to take full advantage of
that opportunity because the opportunity may need to be allocated
among other accounts.
- PURSUIT OF DIFFERING STRATEGIES. At times, the Portfolio Managers may
determine that an investment opportunity may be appropriate for only
some accounts or may decide that certain of these accounts should take
differing positions (i.e., may buy or sell the particular security at
different times or the same time or in differing amounts) with respect
to a particular security. In these cases, the Portfolio Manager may
place separate transactions for one or more accounts which may affect
the market price of the security or the execution of the transaction,
or both, to the detriment of one or more other accounts.
- VARIATION IN COMPENSATION. A conflict of interest may arise where the
financial or other benefits available to the Portfolio Manager differ
among accounts. While the Adviser only charges fees based on assets
under management and does not receive a performance fee from any of
its accounts, and while it strives to maintain uniform fee schedules,
it does have different fee schedules based on the differing advisory
services required by some accounts. Consequently, though the
differences in such fee rates are slight, the Portfolio Managers may
be motivated to favor certain accounts over others. In addition, the
desire to maintain assets under management or to derive other rewards,
financial or otherwise, could
influence the Portfolio Managers in affording preferential treatment
to those accounts that could most significantly benefit the Adviser.
The Adviser and the Fund have adopted compliance policies and procedures that
are designed to address the various conflicts of interest that may arise for the
Adviser and its staff members. However, there is no guarantee that such policies
and procedures will be able to detect and prevent every situation in which an
actual or potential conflict may arise.
(A)(3) PORTFOLIO MANAGER COMPENSATION
Compensation is paid solely by the Adviser. Each Portfolio Manager receives the
same fixed salary. In addition, each Portfolio Manager receives a bonus based on
peer reviews of his performance and the total net investment advisory fees
received by Flaherty & Crumrine (which are in turn based on the value of its
assets under management). The Portfolio Managers do not receive deferred
compensation, but participate in a profit-sharing plan available to all
employees of the Adviser; amounts are determined as a percentage of the
employee's eligible compensation for a calendar year based on IRS limitations.
Each Portfolio Manager is also a shareholder of Flaherty & Crumrine and receives
quarterly dividends based on his equity interest in the company.
(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
The following indicates the dollar range of beneficial ownership of shares by
each Portfolio Manager as of November 30, 2010:
Dollar Range of Fund Shares
Name Beneficially Owned*
---- ---------------------------
Donald F. Crumrine $100,001 to $500,000
Robert M. Ettinger $100,001 to $500,000
R. Eric Chadwick $100,001 to $500,000
Bradford S. Stone $100,001 to $500,000
* INCLUDES 8,603 SHARES HELD BY FLAHERTY & CRUMRINE INCORPORATED OF WHICH
EACH PORTFOLIO MANAGER HAS BENEFICIAL OWNERSHIP.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these
controls and procedures required by Rule 30a-3(b) under the 1940 Act
(17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the
Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act
(17 CFR 270.30a-3(d)) that occurred during the registrant's second
fiscal quarter of the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of ethics, or any amendment thereto, that is the subject of
disclosure required by Item 2 is attached hereto.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) FLAHERTY & CRUMRINE PREFERRED INCOME OPPORTUNITY FUND INCORPORATED
By (Signature and Title)* /s/ Donald F. Crumrine
------------------------------------------
Donald F. Crumrine, Director,
Chairman of the Board and
Chief Executive Officer
(principal executive officer)
Date January 26, 2011
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /s/ Donald F. Crumrine
------------------------------------------
Donald F. Crumrine, Director,
Chairman of the Board and
Chief Executive Officer
(principal executive officer)
Date January 26, 2011
By (Signature and Title)* /s/ R. Eric Chadwick
------------------------------------------
R. Eric Chadwick, Chief Financial Officer,
Treasurer and Vice President
(principal financial officer)
Date January 26, 2011
* Print the name and title of each signing officer under his or her
signature.