-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HtpB2mzw5gApqhjZcLdza8xik4Ji3XUaNTXjHrM+y7OpY2rpKOLjcBbIfUqoigcc SdMr4djOARhqNKRaNFiPBQ== 0000927405-98-000226.txt : 19980729 0000927405-98-000226.hdr.sgml : 19980729 ACCESSION NUMBER: 0000927405-98-000226 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19980531 FILED AS OF DATE: 19980728 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PREFERRED INCOME OPPORTUNITY FUND INC CENTRAL INDEX KEY: 0000882071 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 954355600 STATE OF INCORPORATION: MD FISCAL YEAR END: 1130 FILING VALUES: FORM TYPE: N-30D SEC ACT: SEC FILE NUMBER: 811-06495 FILM NUMBER: 98672599 BUSINESS ADDRESS: STREET 1: 301 E COLORADO BLVD STE 720 STREET 2: C/O FLAHERTY & CRUMRINE INC CITY: PASADENA STATE: CA ZIP: 91101 BUSINESS PHONE: 8187957300 MAIL ADDRESS: STREET 1: 301 COLORADO BLVD STREET 2: STE 720 CITY: PASADENA STATE: CA ZIP: 91101 N-30D 1 PREFERRED INCOME OPPORTUNITY FUND INCORPORATED Dear Shareholder: The Preferred Income Opportunity Fund's portfolio continues to produce good results. The returns on net asset value were 6.5% in the first half of fiscal 1998 and 16.1% for the most recent 12 months. However, the numbers make it look easier than it really was. The success we have enjoyed in fiscal 1998 so far has been primarily due to our active management of the Fund's preferred portfolio. Overall market conditions were of little help at best, and in some ways they were downright unfavorable. At times we felt a little like a salmon swimming up stream. Being in the right place at the right time was critical. All sectors of the Fund's portfolio of hedged preferreds produced good returns and overcame what we spent for our hedges. The strongest contributor was traditional preferreds eligible for the Dividends Received Deduction ("DRD") available to corporate investors. However, adjustable rate preferreds ("ARPs") and hybrid preferred securities also turned in good results. The best returns of all were on our holdings of income oriented common stocks, which represent a very small part of the Fund's portfolio. The market for traditional preferreds eligible for the DRD has become an interesting study in contrasts. As a result of the "creeping scarcity" of such issues (which we have discussed many times before in these letters), many traditional preferreds have reached prices that offer only "ho hum" investment value. At the same time, the small number of new issues of traditional preferreds coming to market has included several extraordinarily attractive special situations. Are we buyers or sellers of traditional preferreds? The answer is "Both!", but probably more of the latter. In the first half of this year, we continued the steady reduction in the Fund's position in ARPs that began over a year ago. These holdings are also eligible for the DRD and have benefited from the creeping scarcity phenomenon. Many of the ARPs that we disposed of were either retired by their issuers at attractive prices or sold by us at prices that anticipated such retirements. This has been a very successful reversal of the substantial increase in the Fund's holdings of ARPs accomplished in 1995 and 1996 when they seemed particularly cheap. Our experience with hybrid preferreds is proof of the old adage that "All's well that ends well." The hybrid market performed rather poorly in the first half of this year, causing problems for investors who were slow to react. In contrast, the Fund traded very actively in this sector of the preferred market and earned a good return on hybrids while the market adjustment was taking place. The end result: We now own significantly more hybrid preferreds, which seem quite attractively valued at their current prices. The Question and Answer Section that follows goes into this in greater detail. As you can see from the pie charts, there has been a significant shift in the Fund's portfolio over the last year from traditional fixed rate and adjustable rate preferreds into hybrid preferreds. It would be nice to say that this was the product of a "grand plan." More realistically, it is just the cumulative result of our efforts each day to buy whatever is cheap and sell whatever is not. This is how we think money should be managed, and it seems to work. [PIE CHARTS] 5/31/97 5/31/98 ------- ------- Preferred Income Opportunity Fund 1.2% 30.7% 19.7% 4.6% 2.0% 3.1% 41.3% 16.8% 47.4% 33.2% -------------------------------------- ---- Adjustable Rates ---- Traditional Fixed Rates ---- Non-DRD Preferreds & Securities (Hybrids) Common Stock ---- Cash & Other -------------------------------------- While all of the foregoing activity was going on in the trenches of our preferred portfolio, interest rates were wandering almost aimlessly. A small decline in interest rates in May represented the only net change for the fiscal first-half. In this kind of environment, our hedging is analogous to buying insurance and never making a claim. Nonetheless, we will continue to hedge until we discover a crystal ball that will tell us in advance when interest rate trends are going to be this boring. We are also pleased to report that the shareholders approved at the Fund's Annual Meeting the "supermajority" requirement proposed by management. This provision will make it more difficult to change certain key aspects of the Fund without widespread support from the directors and the shareholders. These features include the income objective of the Fund, its diversified status, and the prohibition against the Fund attempting to "take over" other companies. I urge you to read the following Question and Answer Section, which contains additional information about your Fund. Sincerely yours, /s/ Robert T. Flaherty Robert T. Flaherty Chairman of the Board June 8, 1998 2 QUESTIONS AND ANSWERS WHAT IS THE DIFFERENCE BETWEEN TRADITIONAL PREFERREDS AND HYBRID PREFERREDS? It is all basically a matter of taxes. In other respects, the two are really very similar. Traditional preferreds are treated for tax purposes just like any other equity security such as common stock. The issuer receives no deduction for tax purposes for the dividend payments made to the holders of the preferred. On the other hand, those dividends are 70% tax free to corporate investors due to the Dividends Received Deduction ("DRD"). The purpose of the DRD is to eliminate in part the double taxation of these dollars at the corporate level that would otherwise occur. Hybrid preferreds were created about 5 years ago for the purpose of allowing issuers to get a deduction for the dividend payments on preferreds, just like they deduct interest payments on debt securities. Since no tax is paid by the issuer, there is no double tax to avoid and no DRD available to a corporate holder of hybrids. Initially, hybrids were primarily purchased by individual investors, but the market has now broadened to include institutions as well. WHY HAS THE EMERGENCE OF HYBRIDS CREATED A "CREEPING SCARCITY" OF TRADITIONAL PREFERREDS? Since the issuer gets a tax deduction, it can afford to pay investors higher rates on hybrid preferreds and still be better off after taxes than if it issued traditional preferreds. At the beginning, the market did not "charge" enough more for hybrids to offset this tax advantage, so issuers concentrated new financing in hybrids, both for raising new capital and for refinancing outstanding issues of traditional preferreds. The following graph highlights rather dramatically the rapid growth in hybrid securities outstanding compared to the sluggish growth and, ultimately, the shrinkage of traditional preferreds. 3 --------------------------------------------- NET PREFERRED STOCK ISSUANCE/(REDEMPTIONS) ---------------------------------------------
Measurement Period HYBRID NET (Fiscal Year Covered) DRD NET ISSUANCE ISSUANCE 1991 3.55 0 1992 7.17 0 1993 3.67 0.55 1994 0.84 3.39 1995 -6.70 10.71 1996 0.04 30.79 1997 -7.07 22.84 1998 -1.74 13.81
WILL THE CREEPING SCARCITY GO ON INDEFINITELY? The market has gotten smarter with the passage of time. Corporate investors interested in the DRD have forced down the yields on the remaining supply of traditional preferreds (by pushing their prices up). Simultaneously, as more companies have issued hybrid preferreds, the market has demanded higher yields for investors to soak up the supply. As a result, the markets have now come into a balance that reasonably reflects the differences in tax treatment. We believe we are close to the point where the two types of preferreds can co-exist "peacefully". The IRS has recently thrown a wild card into this game. It has audited one of the original issuers of hybrids and has challenged in court the favorable tax treatment received by the issuer. The IRS says it cannot see any real difference between hybrid preferreds and equity financing such as traditional preferreds and that the two should be treated the same. There is, of course, no way of knowing now how this dispute might be resolved. A better bet is that Wall Street will find a way around whatever comes out of this case and that hybrid preferreds or similar securities are here to stay. 4 HOW DID THE FUND DO SO WELL IN SUCH A TOUGH MARKET FOR HYBRIDS? The hybrid preferred market suffered from a "one-two punch" in the fiscal first half. First, the financial problems in Asia impacted hybrids along with the corporate bond market generally. Second, a steady stream of 44 new issues of hybrids put additional supply pressure on the market. Relative to the Treasury bond market (which is the basis of our hedges), all 44 new hybrid issues were cheaper on May 31st than when they were initially offered to the public. Selectivity is key in a market like this. We participated, at one time or another, in only 13 of the 44 new hybrid issues and purchased only two in their initial public offerings. Most of our purchases were designed to take advantage of temporary market mispricings that we identified. It was essential to move elsewhere after those opportunities were captured, and we did. Individually, none of these moves was a "big deal"; but collectively, they added up to something very worthwhile. HOW WILL THE GROWTH OF HYBRIDS AFFECT THE PORTION OF THE FUND'S DIVIDENDS QUALIFYING FOR THE DRD? The percentage of the Fund's dividends eligible for the DRD will probably decline as time goes by. This seems like an inevitable result as hybrids account for an ever larger proportion of the overall preferred market. As of May 31, 1998, however, traditional preferreds that qualify for the DRD still accounted for almost two-thirds of the Fund's portfolio. The good news is that increasing the Fund's holdings of hybrids typically has a positive effect on our income. We expect that, over a period of time, this will provide a meaningful offset to the reduced availability of the DRD to our shareholders that are subject to corporate income taxes. 5 IS THERE ANYTHING NEW ON THE DISCOUNT OF THE MARKET PRICE OF THE FUND SHARES FROM NET ASSET VALUE? The following graph tells the story. The discount from net asset value continues to fluctuate in a rather narrow range. This allows the market price of the Fund's shares to reflect the positive performance of their underlying NAV.
Measurement Period (Fiscal Year Covered) PREMIUM/DISCOUNT 7.26 Feb-92 8.05 8.74 9.80 8.19 5.56 5.38 7.05 5.47 5.90 5.46 5.36 3.06 2.48 3.07 2.82 4.00 3.57 4.42 4.75 6.26 8.00 5.92 6.47 6.13 6.28 5.14 5.39 5.06 6.84 4.74 4.41 6.20 6.75 4.90 1.88 2.78 1.80 1.88 4.08 8.44 6.30 6.13 6.91 5.36 6.21 6.79 5.95 4.34 5.76 4.83 2.84 2.02 Feb-93 3.10 4.73 6.51 3.03 4.57 5.14 5.78 5.70 6.59 6.51 5.13 6.10 5.70 4.41 4.97 5.61 4.97 4.17 4.72 4.25 3.62 1.63 3.06 2.12 1.81 0.08 3.70 3.31 4.01 3.38 2.44 2.14 2.61 2.63 2.46 0.90 0.00 -1.07 -2.82 -1.79 -0.76 -3.34 -3.38 -4.31 -1.53 -0.36 1.57 -1.29 -3.77 -3.19 -4.62 -8.63 Feb-94 -5.00 -3.92 -3.15 -5.85 -5.62 -5.52 -5.10 -9.76 -10.12 -10.42 -7.75 -7.37 -6.36 -3.12 -6.83 -2.88 -4.57 -3.93 -4.09 -3.44 -4.90 -2.94 -3.27 -2.21 -2.98 -3.76 -2.94 -2.04 -3.18 -4.09 -6.28 -5.10 -13.22 -13.68 -14.10 -10.40 -7.86 -10.87 -9.90 -7.70 -4.02 -8.68 -7.32 -6.04 -8.51 -0.10 -1.41 -4.21 -6.19 -2.34 -3.14 -5.88 Feb-95 -3.76 -2.97 -5.85 -5.23 -5.34 -3.93 -3.41 -3.93 -6.90 -3.41 -5.76 -3.93 -9.33 -7.53 -4.81 -7.29 -8.07 -7.49 -6.86 -6.90 -7.64 -10.87 -9.11 -9.73 -10.18 -10.11 -7.80 -7.06 -8.33 -8.13 -7.49 -6.41 -7.18 -10.06 -9.09 -10.12 -12.32 -11.15 -10.71 -9.91 -10.14 -11.74 -12.33 -12.65 -14.54 -11.97 -12.79 -13.12 -11.46 -12.33 -12.33 -12.79 Feb-96 -13.03 -11.24 -14.65 -15.08 -14.87 -15.15 -13.15 -12.86 -12.79 -13.83 -11.53 -11.30 -14.08 -13.86 -13.86 -12.55 -13.37 -13.01 -9.18 -10.79 -10.13 -11.22 -9.39 -8.76 -6.88 -6.73 -7.79 -8.36 -8.36 -6.61 -9.91 -9.91 -8.76 -8.76 -9.35 -8.34 -7.96 -9.32 -6.30 -5.86 -6.08 -7.92 -8.13 -10.09 -8.37 -6.93 -5.62 -6.93 -8.34 -6.78 -6.23 -5.51 -6.45 Feb-97 -6.05 -5.81 -6.54 -7.15 -7.15 -5.73 -7.77 -9.04 -7.48 -6.72 -6.18 -6.47 -5.73 -3.62 -6.15 -4.81 -4.73 -4.18 -4.98 -5.85 -4.86 -6.30 -2.73 -7.01 -8.09 -7.67 -4.72 -5.80 -6.56 -5.10 -4.92 -2.92 -4.92 -5.06 -5.27 -4.77 -4.42 -3.77 -6.41 -5.76 -4.98 -4.69 -6.48 -5.02 -1.71 -1.97 -1.85 -6.20 -4.77 -5.30 -6.04 -3.63 Feb-98 -4.77 -4.27 -5.68 -4.87 -5.79 -6.82 -5.08 -6.20 -7.68 -5.18 -5.40 -7.17 -7.10 -6.48 = = = = = = = = = = = = = = = = = = = -
6 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated FINANCIAL DATA PER SHARE OF COMMON STOCK (UNAUDITED) ---------------------------------------------------
DIVIDEND DIVIDEND NET ASSET NYSE REINVESTMENT PAID VALUE CLOSING PRICE PRICE(1) -------- --------- ------------- ------------- December 31, 1996................................... $0.280 $12.56 $11.6250 $11.65 January 31, 1997.................................... 0.073 12.47 11.6250 11.69 February 28, 1997................................... 0.073 12.64 11.8750 12.01 March 31, 1997...................................... 0.073 12.81 12.0000 12.03 April 30, 1997...................................... 0.073 12.72 11.8750 12.03 May 31, 1997........................................ 0.073 12.84 12.3750 12.44 June 30, 1997....................................... 0.073 12.96 12.5000 12.52 July 31, 1997....................................... 0.073 13.35 12.9375 12.98 August 31, 1997..................................... 0.073 13.25 12.6250 12.84 September 30, 1997.................................. 0.073 13.42 13.0000 12.94 October 31, 1997.................................... 0.073 13.52 12.8750 12.94 November 30, 1997................................... 0.073 13.53 12.8750 12.88 December 31, 1997................................... 0.325 13.46 13.0000 13.40 January 31, 1998.................................... 0.068 13.52 12.8750 12.95 February 28, 1998................................... 0.068 13.52 12.8750 12.96 March 31, 1998...................................... 0.068 13.62 12.8125 12.92 April 30, 1998...................................... 0.068 13.59 12.6250 12.75 May 31, 1998........................................ 0.068 13.70 12.8125 12.92
- --------------- (1) See ADDITIONAL INFORMATION; Dividend Reinvestment and Cash Purchase Plan on pages 25 and 26 of this report. 7 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated PORTFOLIO OF INVESTMENTS MAY 31, 1998 (UNAUDITED) - --------------------------------------------
VALUE SHARES/PAR (NOTE 1) - ---------- -------- PREFERRED STOCKS AND SECURITIES -- 94.3 % ADJUSTABLE RATE PREFERRED STOCKS -- 19.8 % UTILITIES -- 7.6 % 22,470 Arizona Public Service Company, Series Q, Adj. Rate Pfd. ...... $ 2,238,557 264,504 New York State Electric & Gas Corporation, Series B, Adj. Rate Pfd. ...... 6,381,159 Niagara Mohawk Power Corporation: 95,275 Series A, Adj. Rate Pfd. ........ 2,352,102 195,918 Series B, Adj. Rate Pfd. ........ 4,977,542 25,000 Series C, Adj. Rate Pfd. ........ 633,594 6,800 Northern Indiana Public Service Company, Series A, Adj. Rate Pfd. ...... 340,850 ------------ TOTAL UTILITY ADJUSTABLE RATE PREFERRED STOCKS............... 16,923,804 ------------ BANKING -- 12.2 % BankAmerica Corporation: 9,050 Series A, Adj. Rate Pfd. ........ 453,066 9,700 Series B, Adj. Rate Pfd. ........ 971,213 BankBoston Corporation: 9,800 Series A, Adj. Rate Pfd. ........ 490,000 65,600 Series B, Adj. Rate Pfd. ........ 3,280,000 38,300 Series C, Adj. Rate Pfd. ........ 3,820,425 Bankers Trust New York Corporation: 188,500 Series Q, Adj. Rate Pfd. ........ 4,677,156 45,000 Series R, Adj. Rate Pfd. ........ 1,116,563 Chase Manhattan Corporation: 24,650 Series L, Adj. Rate Pfd. ........ 2,463,459 10,000 Series N, Adj. Rate Pfd. ........ 250,000 25,000 19th Series, Adj. Rate Pfd. ..... 621,875 First Chicago NBD: 9,011 Series B, Adj. Rate Pfd. ........ 903,353 20,000 Series C, Adj. Rate Pfd. ........ 2,011,250 49,650 Morgan (J.P.) & Company Inc., Series A, Adj. Rate Pfd........ 4,741,575 7,600 Republic New York Corporation, Series D, Adj. Rate Pfd. ...... 190,475
VALUE SHARES/PAR (NOTE 1) - ---------- -------- 22,700 Wells Fargo & Company, Series B, Adj. Rate Pfd. ...... $ 1,115,138 ------------ TOTAL BANKING ADJUSTABLE RATE PREFERRED STOCKS............... 27,105,548 ------------ TOTAL ADJUSTABLE RATE PREFERRED STOCKS............... 44,029,352 ------------ FIXED RATE PREFERRED STOCKS AND SECURITIES -- 74.5 % UTILITIES -- 36.8 % Alabama Power Company: 116,406 Class A, 6.40% Pfd. ............. 2,975,628 12,000 Series A, 7.125% Sr. Notes ...... 295,950 287 4.60% Pfd. ...................... 24,646 172 4.72% Pfd. ...................... 15,158 100 4.92% Pfd. ...................... 9,188 58,100 7.375% TOPRS..................... 1,470,656 80,000 7.60% TOPRS...................... 2,055,000 Appalachian Power Company: 59,550 Series A, 8.25% TOPRS............ 1,552,022 40,400 Series B, 8.00% TOPRS............ 1,032,725 22,646 Arizona Public Service Company, Series W, 7.25% Pfd. .......... 576,058 Baltimore Gas & Electric Company: 10,650 Series 1993, 6.70% Pfd. ......... 1,208,775 48,800 Series 1995, 6.99% Pfd. ......... 5,740,100 10,000 Boston Edison Company, 4.78% Pfd. .................... 872,500 267 Central Hudson Gas & Electric Corporation, Series D, 4.35% Pfd. .......... 21,126 18,000 Columbus Southern Power Company, Series B, 7.92% Jr. Sub. Debt........................... 455,625 7,500 Commonwealth Edison Company, $8.40 Pfd. .................... 772,500 29,000 Consolidated Edison Company of New York, Series A, 7.75% QUICS.......... 744,938 75,000 CPL Capital, Series A, 8.00% QUIPS.......... 1,926,563
See Notes to Financial Statements. 8 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated PORTFOLIO OF INVESTMENTS (CONTINUED) MAY 31, 1998 (UNAUDITED) ---------------------------------------------------------------
VALUE SHARES/PAR (NOTE 1) - ---------- -------- PREFERRED STOCKS AND SECURITIES (CONTINUED) FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED) UTILITIES (CONTINUED) Duke Power Company: 7,019 Series C, 4.50% Pfd. ............ $ 604,511 10,003 Series S, 7.85% Pfd. ............ 1,164,099 1,009 Series W, 7.00% Pfd. ............ 113,891 53,750 Duquesne Capital, Series A, 8.375% MIPS.......... 1,387,422 26,000 Duquesne Light, 7.375% QUIBS................... 649,025 5,050 El Paso, Tennessee Pipeline Company, Series A, 8.25% Pfd. .......... 286,588 Florida Power & Light Company: 4,000 4.50% Pfd. ...................... 341,000 4,105 Series E, 4.35% Pfd. ............ 329,426 32,850 Series S, 6.98% Pfd. ............ 3,695,625 18,100 Series T, 7.05% Pfd. ............ 2,054,350 Georgia Power Company: 1,246 $6.48 Pfd. ...................... 130,519 3,481 $6.60 Pfd. ...................... 364,635 13,500 7.75% TOPRS...................... 348,469 10,000 Gulf Power Company, Series A, 7.625% QUIPS......... 255,625 Hawaiian Electric Industries: 20,000 8.05% QUIPS...................... 511,250 23,500 8.36% TOPRS...................... 612,469 14,250 Indianapolis P&L, 5.65% Pfd. .................... 1,494,469 10,000 Jersey Central Power & Light Company, Series K, 7.52% Sinking Fund Pfd. .......................... 1,045,625 18,500 Long Island Lighting, 7.95% Sinking Fund Pfd. ....... 486,781 15,000 Mississippi Power Company, 6.32% Pfd. .................... 385,313 Monongahela Power Company: 24,000 Series A, 8.00% QUIDS............ 625,500 20,000 Series L, $7.73 Pfd. ............ 2,345,000 3,900 Montana Power Company, $6.875 Pfd. ................... 442,650 10,000 MP&L Capital, 8.05% QUIPS.................... 256,875
VALUE SHARES/PAR (NOTE 1) - ---------- -------- New York State Electric & Gas Corporation: 5,000 6.30% Sinking Fund Pfd. ......... $ 522,188 7,481 6.48% Pfd. ...................... 775,219 Niagara Mohawk Power Corporation: 6,250 4.10% Pfd. ...................... 406,250 35,720 7.85% Sinking Fund Pfd. ......... 913,093 62,000 9.50% Pfd. ...................... 1,646,875 Northern States Power Company: 2,480 $4.10 Pfd. ...................... 193,130 2,660 $4.16 Pfd. ...................... 210,140 75,000 NSP Financing, 7.875% TOPRS................... 1,935,938 28,360 NVP Capital I, Series A, 8.20% QUIPS.......... 728,498 Ohio Power Company: 75,800 7.375% Sr. Notes................. 1,892,158 47,500 Series B, 7.92% QUIDS............ 1,202,344 2,150 Pacific Enterprises, $4.50 Pfd. .................... 177,375 2,493 Potomac Electric Power Company, Series 1957, $2.44 Pfd. ....... 113,743 PP&L Capital Trust: 86,900 8.10% TOPRS...................... 2,253,969 30,400 8.20% TOPRS...................... 788,500 49,000 PSCO Capital Trust, 7.60% TOPRS.................... 1,228,063 12,350 PSI Energy, Inc., 6.875% Pfd. ................... 1,392,463 5,776 Public Service Company of Colorado, 4.64% Pfd. .................... 491,682 1,050,000 Puget Sound Energy Capital Trust, Series B, 8.231% 6/1/27 Capital Security....................... 1,143,188 Puget Sound Power & Light Company: 27,555 7.75% Sinking Fund Pfd. ......... 2,927,719 125,300 Series II, 7.45% Pfd. ........... 3,602,375 4,030 Rochester Gas & Electric Corporation, Series I, 4.75% Pfd. .......... 342,550 68,800 San Diego Gas & Electric Company, 6.80% Pfd. .................... 1,965,100 26,000 Sierra Pacific Capital, 8.60% TOPRS.................... 684,125
See Notes to Financial Statements. 9 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated PORTFOLIO OF INVESTMENTS (CONTINUED) MAY 31, 1998 (UNAUDITED) - ---------------------------------------------------------------
VALUE SHARES/PAR (NOTE 1) - ---------- -------- PREFERRED STOCKS AND SECURITIES (CONTINUED) FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED) UTILITIES (CONTINUED) South Carolina Electric & Gas: 10,188 5.125% Sinking Fund Pfd. ........ $ 480,110 44,000 7.55% TOPRS...................... 1,119,250 4,000 Southern Indiana Gas & Electric, 4.75% Pfd. .................... 352,000 35,000 Southwestern Public Service Company, 7.85% TOPRS.................... 894,688 57,300 TransCanada Pipeline Ltd., 8.75% COPRS.................... 1,514,869 Union Electric Power Company: 3,000 $7.64 Pfd. ...................... 348,000 4,000,000 $7.69 12/15/36 Capital Security....................... 4,185,000 Virginia Electric & Power Company: 1,136 $4.04 Pfd. ...................... 88,040 1,420 $4.20 Pfd. ...................... 114,310 27,300 $6.98 Pfd. ...................... 3,074,663 5,500 Wisconsin Power & Light Company, 6.20% Pfd. .................... 603,625 ------------ TOTAL UTILITY FIXED RATE PREFERRED STOCKS AND SECURITIES..................... 81,991,515 ------------ BANKING -- 10.2 % 500 ABN Amro North America, 6.59% Pfd. 144A**.............. 553,750 1,275,000 BankBoston Capital Trust, Series B, 7.75% 12/15/26 Capital Security............... 1,337,156 21,000 Bankers Trust New York Corporation, Series O, 7.625% Pfd. ......... 525,000 540,000 Bank of New York, 7.78% 12/1/26 Capital Security 144A**......................... 571,050 1,750,000 BNY Capital, Series B, 7.97% 12/31/26 Capital Security............... 1,890,000 1,500,000 BT Preferred Capital Trust, 7.875% 2/25/27 Capital Security....................... 1,554,375 2,600,000 Chase Capital, 7.67% 12/1/26 Capital Security....................... 2,726,750
VALUE SHARES/PAR (NOTE 1) - ---------- -------- 101,050 Chase Manhattan Corporation, Series C, 10.84% Pfd. ......... $ 3,126,234 1,000,000 Citicorp Capital, 8.015% 2/15/27 Capital Security....................... 1,086,250 2,500,000 First Hawaiian Capital, Series B, 8.343% 7/1/27 Capital Security....................... 2,721,875 300,000 First Union Institutional, 8.04% 12/1/26 Capital Security 144A**......................... 324,750 Fleet Financial Group, Inc.: 12,300 Series VI, 6.75% Pfd. ........... 699,563 35,000 Series E, 9.35% Pfd. ............ 967,969 700,000 Great Western Financial Corporation, 8.206% 2/1/27 Capital Security....................... 757,750 750 La Salle National Corporation, 6.46% Pfd. .................... 826,875 35,500 NB Capital Trust, 7.84% TOPRS.................... 916,344 1,985,000 Republic New York Capital, 7.53% 12/4/26 Capital Security....................... 2,066,881 3,200 Republic New York Corporation, 5.715% Pfd. ................... 167,600 ------------ TOTAL BANKING FIXED RATE PREFERRED STOCKS AND SECURITIES..................... 22,820,172 ------------ FINANCIAL SERVICES -- 14.4 % 38,300 Bear Stearns Co., Series E, 6.15% Pfd. .......... 2,072,988 27,000 DLJ Capital Trust, 8.42% MIPS..................... 707,063 15,000 Heller Financial, 6.687% Pfd. 144A**............. 1,661,250 174,950 Household International, Inc., 8.70% TOPRS.................... 4,647,109 Lehman Brothers Holdings Inc.: 94,225 5.00% Conv. Pfd. ................ 3,450,991 65,000 Series A, 8.30% QUICS............ 1,685,938 52,000 Series C, 5.94% Pfd. ............ 2,743,000 Merrill Lynch & Company, Inc.: 30,000 8.00% TOPRS...................... 800,625 104,200 Series A, 9.00% Pfd. ............ 3,340,913
See Notes to Financial Statements. 10 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated PORTFOLIO OF INVESTMENTS (CONTINUED) MAY 31, 1998 (UNAUDITED) ---------------------------------------------------------------
VALUE SHARES/PAR (NOTE 1) - ---------- -------- PREFERRED STOCKS AND SECURITIES (CONTINUED) FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED) FINANCIAL SERVICES (CONTINUED) Travelers Group: 6,500 Series G, 6.213% Pfd. ........... $ 355,063 124,680 Series H, 6.231% Pfd. ........... 6,872,985 70,100 Series M, 5.864% Pfd. ........... 3,697,775 ------------ TOTAL FINANCIAL SERVICES FIXED RATE PREFERRED STOCKS AND SECURITIES..................... 32,035,700 ------------ INSURANCE -- 7.0 % 3,270,000 Allstate Financing, 7.83% 12/01/45 Capital Security....................... 3,470,288 300,000 American General Capital, 7.57% Capital Security, 144A**......................... 317,625 71,481 Hartford Capital, Series B, 8.35% QUIPS.......... 1,898,714 3,700,000 MMI Capital Trust, Series B, 7.625% 12/15/27 Capital Security............... 3,806,375 2,950,000 Orion Capital Trust, 7.701% 4/15/28 144A** Capital Security....................... 3,034,813 1,000,000 Provident Companies Inc., 7.405% 3/15/38 Capital Security....................... 1,022,500 21 Prudential Human Resources Management Company, 6.30% Private, Sinking Fund Pfd. .......................... 2,136,750 ------------ TOTAL INSURANCE FIXED RATE PREFERRED STOCKS AND SECURITIES..................... 15,687,065 ------------ MISCELLANEOUS INDUSTRIES -- 6.1 % 118,300 Coastal Finance, 8.375% 6/30/38 TOPRS........... 2,964,894 3,000 E.I. du Pont de Nemours and Company, Series B, $4.50 Pfd. .......... 255,750
VALUE SHARES/PAR (NOTE 1) - ---------- -------- 55,000 Farmland Industries, 8.00% Pfd. 144A**.............. $ 3,478,750 3,300 Time Warner Inc., Series M, 10.25% Pfd. ......... 3,818,100 19,600 Union Texas Petroleum Holdings, Series A, 7.14% Pfd. .......... 2,418,150 9,520 Viad Corporation, $4.75 Sinking Fund Pfd. ....... 754,460 ------------ TOTAL MISCELLANEOUS FIXED RATE PREFERRED STOCKS AND SECURITIES..................... 13,690,104 ------------ TOTAL FIXED RATE PREFERRED STOCKS AND SECURITIES................. 166,224,556 ------------ TOTAL PREFERRED STOCKS AND SECURITIES (Cost $191,948,284)............ 210,253,908 ------------ COMMON STOCKS -- 4.6 % UTILITIES -- 4.6 % 19,000 Energy East Corporation.......... 774,250 220,800 Nevada Power Company............. 5,292,300 20,000 New England Electric System...... 837,500 11,200 Northern States Power Company.... 635,950 33,000 Scana Corporation................ 952,875 40,700 Wisconsin Energy Corporation..... 1,203,194 15,700 WPS Resources Corporation........ 491,606 ------------ TOTAL UTILITY COMMON STOCKS (Cost $8,985,052)................ 10,187,675 ------------
See Notes to Financial Statements. 11 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated PORTFOLIO OF INVESTMENTS (CONTINUED) MAY 31, 1998 (UNAUDITED) - ---------------------------------------------------------------
VALUE SHARES/PAR (NOTE 1) - ---------- -------- MISCELLANEOUS SECURITIES -- 0.3 % (Cost $1,509,276) September Put Options on U.S. Treasury Bond Futures, expiring 8/22/98+....................... $ 637,813 ------------ COMMERCIAL PAPER -- 0.3 % (Cost $764,000) $764,000 General Electric Capital Corporation, 5.66% due 06/01/98............. 764,000 ------------ TOTAL INVESTMENTS (Cost $203,206,612*).. 99.5% 221,843,396 OTHER ASSETS AND LIABILITIES(Net)....... 0.5 1,200,851 ------ ------------ NET ASSETS.............................. 100.0% $223,044,247 ====== ============
- --------------- * Aggregate cost for Federal tax purposes. ** Security exempt from registration under Rule 144A of the Securities Act of 1933. These securities may be resold in transactions exempt from registration to qualified institutional buyers. + Non-income producing. ABBREVIATIONS (Note 6): TOPRS -- Trust Originated Preferred Securities MIPS -- Monthly Income Preferred Securities QUIPS -- Quarterly Income Preferred Securities QUIDS -- Quarterly Income Debt Securities COPRS -- Canadian Originated Preferred Securities QUICS -- Quarterly Income Capital Securities QUIBS -- Quarterly Interest Bonds Capital Securities are debt instruments and the amounts shown in the Shares/Par column are dollar amounts of par value.
See Notes to Financial Statements. 12 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated STATEMENT OF ASSETS AND LIABILITIES MAY 31, 1998 (UNAUDITED) - ------------------------------------------------------------- ASSETS: Investments, at value (Cost $203,206,612) (Note 1) See accompanying schedule.............................. $221,843,396 Cash...................................................... 100 Receivable for securities sold............................ 1,073,626 Dividends and interest receivable......................... 1,613,523 Prepaid expenses.......................................... 53,019 ------------ Total Assets...................................... 224,583,664 LIABILITIES: Payable for securities purchased.......................... $ 1,064,531 Dividends payable to Common Shareholders.................. 192,827 Investment advisory fee payable (Note 2).................. 104,891 Accrued expenses and other payables....................... 177,168 ----------- Total Liabilities................................. 1,539,417 ------------ NET ASSETS.................................................. $223,044,247 ============ NET ASSETS consist of: Accumulated distributions in excess of net investment income (Note 1)........................................ $ (169,241) Accumulated net realized gain on investments sold (Note 1)..................................................... 5,660,875 Unrealized appreciation of investments (Note 3)........... 18,636,784 Par value of Common Stock................................. 111,513 Paid-in capital in excess of par value of Common Stock.... 128,804,316 Money Market Cumulative Preferred(TM) Stock (Note 5)...... 70,000,000 ------------ Total Net Assets.................................. $223,044,247 ============ PER SHARE --------- NET ASSETS AVAILABLE TO: Money Market Cumulative Preferred(TM) Stock (700 shares outstanding) redemption value.......................... $100,000.00 $ 70,000,000 Accumulated undeclared dividends on Money Market Cumulative Preferred(TM) Stock......................... 365.24 255,671 ----------- ------------ $100,365.24 70,255,671 =========== Common Stock (11,151,287 shares outstanding).............. $13.70 152,788,576 ====== ------------ TOTAL NET ASSETS............................................ $223,044,247 ============
See Notes to Financial Statements. 13 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED MAY 31, 1998 (UNAUDITED) --------------------------------------------------------------- INVESTMENT INCOME: Dividends.............................................. $ 6,262,871 Interest............................................... 1,114,736 ----------- Total Investment Income........................... 7,377,607 EXPENSES: Investment advisory fee (Note 2)....................... $ 614,993 Administration fee (Note 2)............................ 132,640 Money Market Cumulative Preferred(TM) broker commissions and Auction Agent fees.................... 112,738 Insurance expense...................................... 38,961 Legal and audit fees................................... 33,373 Directors' fees and expenses (Note 2).................. 29,141 Shareholder servicing agent fees (Note 2).............. 24,698 Economic consulting fee (Note 2)....................... 22,667 Custodian fees (Note 2)................................ 16,593 Other.................................................. 90,086 ---------- Total Expenses.................................... 1,115,890 ----------- NET INVESTMENT INCOME....................................... 6,261,717 ----------- REALIZED AND UNREALIZED GAIN ON INVESTMENTS (Notes 1 and 3): Net realized gain on investments sold during the period................................................ 4,650,805 Change in net unrealized appreciation of investments during the period..................................... 32,244 ----------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS............. 4,683,049 ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $10,944,766 ===========
See Notes to Financial Statements. 14 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated STATEMENT OF CHANGES IN NET ASSETS - ---------------------------------------------------------------
SIX MONTHS ENDED MAY 31, 1998 YEAR ENDED (UNAUDITED) NOVEMBER 30, 1997 ---------------- ----------------- OPERATIONS: Net investment income.................................. $ 6,261,717 $ 12,304,022 Net realized gain on investments sold during the period................................................ 4,650,805 2,977,646 Change in net unrealized appreciation of investments during the period..................................... 32,244 6,639,359 ------------ ------------ Net increase in net assets resulting from operations... 10,944,766 21,921,027 DISTRIBUTIONS: Dividends paid from net investment income to Money Market Cumulative Preferred(TM) Stock Shareholders (Note 5).............................................. (1,682,907) (2,350,442) Distributions paid from net realized capital gains to Money Market Cumulative Preferred(TM) Stock Shareholders (Note 5)................................. (32,478) (457,916) Dividends paid from net investment income to Common Stock Shareholders.................................... (5,371,574) (10,345,646) Distributions paid from net realized capital gains to Common Stock Shareholders............................. (2,044,031) (1,731,258) ------------ ------------ NET INCREASE IN NET ASSETS FOR THE PERIOD................... 1,813,776 7,035,765 NET ASSETS: Beginning of period.................................... 221,230,471 214,194,706 ------------ ------------ End of period (including accumulated distributions in excess of net investment income/undistributed net investment income of $(169,241) and $623,523, respectively)......................................... $223,044,247 $221,230,471 ============ ============
See Notes to Financial Statements. 15 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated FINANCIAL HIGHLIGHTS FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD. --------------------------------------------------------------------- Contained below is per share operating performance data, total investment returns, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements and market price data for the Fund's shares.
SIX MONTHS ENDED MAY 31, YEAR ENDED NOVEMBER 30, 1998 --------------------------------------------------------- (UNAUDITED) 1997 1996 1995 1994 1993 ----------- -------- -------- -------- --------- -------- OPERATING PERFORMANCE: Net asset value, beginning of period................... $ 13.53 $ 12.91 $ 12.35 $ 10.92 $ 13.17 $ 12.69 -------- -------- -------- -------- --------- -------- Net investment income.................................. 0.56 1.10 1.16 1.27 1.19 1.19 Net realized and unrealized gain/(loss) on investments........................................... 0.41 0.87 0.53 1.73 (1.64) 0.92 -------- -------- -------- -------- --------- -------- Net increase/(decrease) in net asset value............. 0.97 1.97 1.69 3.00 (0.45) 2.11 -------- -------- -------- -------- --------- -------- DISTRIBUTIONS: Dividends paid from net investment income to MMP* Shareholders.......................................... (0.15) (0.21) (0.21) (0.31) (0.18) (0.15) Distributions paid from net realized capital gains to MMP* Shareholders..................................... (0.00)# (0.04) (0.03) (0.00)# (0.03) (0.05) Dividends paid from net investment income to Common Stock Shareholders.................................... (0.48) (0.92) (0.87) (1.11) (0.86) (1.18) Distributions paid from net realized capital gains to Common Stock Shareholders............................. (0.18) (0.16) -- (0.17) (0.72) (0.26) Change in accumulated undeclared dividends on MMP*..... 0.01 (0.02) (0.02) 0.02 (0.01) 0.01 -------- -------- -------- -------- --------- -------- Total distributions.................................... (0.80) (1.35) (1.13) (1.57) (1.80) (1.63) -------- -------- -------- -------- --------- -------- Net asset value, end of period......................... $ 13.70 $ 13.53 $ 12.91 $ 12.35 $ 10.92 $ 13.17 ======== ======== ======== ======== ========= ======== Market value, end of period............................ $ 12.813 $ 12.875 $ 12.000 $ 11.250 $ 10.125 $ 13.250 ======== ======== ======== ======== ========= ======== Total investment return based on net asset value***.... 6.47% 14.44% 13.11% 27.25% (5.44)% 16.04% ======== ======== ======== ======== ========= ======== Total investment return based on market value***....... 4.64% 17.16% 15.42% 25.02% (12.83)% 8.70% ======== ======== ======== ======== ========= ======== RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK SHAREHOLDERS: Operating expenses.................................. 1.47%** 1.48% 1.71% 1.78% 1.69% 1.72% Net investment income****........................... 6.16%** 6.44% 7.36% 8.47% 8.31% 7.65% SUPPLEMENTAL DATA: Portfolio turnover rate............................. 53% 74% 87% 94% 116% 129% Net assets, end of period (in 000's)................ $223,044 $221,230 $214,195 $207,720 $ 191,797 $213,569 - ----------------------------------------------------- Ratio of operating expenses to Total Average Net Assets including MMP*........................................ 1.01%** 1.00% 1.13% 1.13% 1.11% 1.14%
* Money Market Cumulative Preferred(TM) Stock. ** Annualized. *** Assumes reinvestment of distributions at the price obtained by the Fund's Dividend Reinvestment Plan. **** The net investment income ratios reflect income net of operating expenses and payments to MMP* Shareholders. # Amount represents less than $0.01 per share. See Notes to Financial Statements. 16 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated FINANCIAL HIGHLIGHTS (CONTINUED) - ------------------------------------------------------ The table below sets out information with respect to Money Market Cumulative Preferred(TM) Stock currently outstanding.
INVOLUNTARY AVERAGE ASSET LIQUIDATING MARKET TOTAL SHARES COVERAGE PREFERENCE VALUE OUTSTANDING PER SHARE PER SHARE(1) PER SHARE(1) & (2) ------------ --------- ------------ ------------------ 05/31/98* 700 $318,608 $100,000 $100,000 11/30/97 700 316,044 100,000 100,000 11/30/96 700 305,992 100,000 100,000 11/30/95 700 296,743 100,000 100,000 11/30/94 700 273,996 100,000 100,000 11/30/93 700 305,099 100,000 100,000 11/30/92 700 286,384 100,000 100,000
- --------------- (1) Excludes accumulated undeclared dividends. (2) See Note 5. * Unaudited. See Notes to Financial Statements. 17 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated NOTES TO FINANCIAL STATEMENTS (UNAUDITED) ------------------------------------------------------------------------ 1. SIGNIFICANT ACCOUNTING POLICIES Preferred Income Opportunity Fund Incorporated (the "Fund") is a diversified, closed-end management investment company organized as a Maryland corporation on December 10, 1991 and is registered with the Securities and Exchange Commission ("SEC") under the Investment Company Act of 1940, as amended. The Fund commenced operations on February 13, 1992. The policies described below are followed consistently by the Fund in the preparation of its financial statements in conformity with generally accepted accounting principles. Portfolio valuation: The net asset value of the Fund's Common Stock is determined by the Fund's administrator no less frequently than on the last business day of each week and month. It is determined by dividing the value of the Fund's net assets attributable to common shares by the number of shares of Common Stock outstanding. The value of the Fund's net assets attributable to common shares is deemed to equal the value of the Fund's total assets less (i) the Fund's liabilities, (ii) the aggregate liquidation value of the outstanding Money Market Cumulative Preferred(TM) Stock and (iii) accumulated and unpaid dividends on the outstanding Money Market Cumulative Preferred(TM) Stock. Securities listed on a national securities exchange are valued on the basis of the last sale on such exchange on the day of valuation. In the absence of sales of listed securities and with respect to securities for which the most recent sale prices are not deemed to represent fair market value and unlisted securities (other than money market instruments), securities are valued at the mean between the closing bid and asked prices when quoted prices for investments are readily available. Investments for which market quotations are not readily available are valued at fair value as determined in good faith by or under the direction of the Board of Directors of the Fund, including reference to valuations of other securities which are considered comparable in quality, maturity and type. Investments in money market instruments, which mature in 60 days or less, are valued at amortized cost. Securities transactions and investment income: Securities transactions are recorded as of the trade date. Realized gains and losses from securities sold are recorded on the identified cost basis. Dividend income is recorded on ex-dividend dates. Interest income is recorded on the accrual basis. Option accounting principles: Upon the purchase of a put option by the Fund, the total purchase price paid is recorded as an investment. The market valuation is determined as set forth in the second preceding paragraph. When the Fund enters into a closing sale transaction, the Fund will record a gain or loss depending on the difference between the purchase and sale price. The risks associated with purchasing options and the maximum loss the Fund would incur are limited to the purchase price originally paid. Repurchase Agreements: The Fund may engage in repurchase agreement transactions. The Fund's Board of Directors reviews and approves periodically the eligibility of the banks and dealers with which the Fund enters into repurchase agreement transactions. The value of the collateral underlying such transactions is at least equal at all times to the total amount of the repurchase obligations, including 18 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- interest. The Fund maintains possession of the collateral and, in the event of counterparty default, the Fund has the right to use the collateral to offset losses incurred. There is the possibility of loss to the Fund in the event the Fund is delayed or prevented from exercising its rights to dispose of the collateral securities. Dividends and distributions to shareholders: The Fund expects to declare dividends on a monthly basis to shareholders of Common Stock. The shareholders of Money Market Cumulative Preferred(TM) Stock are entitled to receive cumulative cash dividends as declared by the Fund's Board of Directors. Distributions to shareholders are recorded on the ex-dividend date. Any net realized short-term capital gains will be distributed to shareholders at least annually. Any net realized long-term capital gains may be distributed to shareholders at least annually or may be retained by the Fund as determined by the Fund's Board of Directors. Capital gains retained by the Fund are subject to tax at the corporate tax rate. Subject to the Fund qualifying as a regulated investment company, any taxes paid by the Fund on such net realized long-term gains may be used by the Fund's Shareholders as a credit against their own tax liabilities. Federal income taxes: The Fund intends to 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. Income and capital gain distributions are determined and characterized in accordance with income tax regulations which may differ from generally accepted accounting principles. These differences are primarily due to (1) differing treatments of income and gains on various investment securities held by the Fund, including timing differences, (2) the attribution of expenses against certain components of taxable investment income, and (3) federal regulations requiring proportional allocation of income and gains to all classes of Shareholders. The Internal Revenue Code of 1986, as amended, imposes a 4% nondeductible excise tax on the Fund to the extent the Fund does not distribute by the end of any calendar year at least (1) 98% of the sum of its net investment income for that year and its capital gains (both long-term and short-term) for its fiscal year and (2) certain undistributed amounts from previous years. Other: The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from those estimates. 19 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- 2. INVESTMENT ADVISORY FEE, DIRECTORS' FEES, ECONOMIC CONSULTING FEE, ADMINISTRATION FEE AND TRANSFER AGENT FEE Flaherty & Crumrine Incorporated (the "Adviser") serves as the Fund's Investment Adviser. The Fund pays the Adviser a monthly fee at an annual rate of 0.625% of the value of the Fund's average monthly net assets up to $100 million and 0.50% of the value of the Fund's average monthly net assets in excess of $100 million. The Fund currently pays each Director who is not a director, officer or employee of the Adviser a fee of $9,000 per annum, plus $500 for each in-person meeting of the Board of Directors or any committee and $100 for each telephone meeting. In addition, the Fund will reimburse all Directors for travel and out- of-pocket expenses incurred in connection with such meetings. Primark Decision Economics Inc. ("Primark") serves as the Fund's Economic Consultant. The Fund pays Primark an annual fee equal to $45,333 for services provided. First Data Investor Services Group, Inc. ("Investor Services Group"), a wholly owned subsidiary of First Data Corporation, serves as the Fund's Administrator and Transfer Agent. As Administrator, Investor Services Group calculates the net asset value of the Fund's shares and generally assists in all aspects of the Fund's administration and operation. As compensation for Investor Services Group's services as Administrator, the Fund pays Investor Services Group a monthly fee at an annual rate of 0.12% of the Fund's average monthly net assets. Boston Safe Deposit and Trust Company ("Boston Safe"), a wholly owned subsidiary of Mellon Bank Corporation, serves as the Fund's Custodian. As compensation for Boston Safe's services as Custodian, the Fund pays Boston Safe a monthly fee at an annual rate of 0.01% of the Fund's average monthly net assets. Investor Services Group also serves as the Fund's Common Stock servicing agent (transfer agent), dividend-paying agent and registrar, and as compensation for Investor Services Group's services as transfer agent, the Fund pays Investor Services Group a fee at an annual rate of 0.02% of the Fund's average monthly net assets plus certain out-of-pocket expenses. Chase Manhattan Bank ("Auction Agent") serves as the Fund's Money Market Cumulative Preferred(TM) Stock transfer agent, registrar, dividend disbursing agent and redemption agent. 3. PURCHASES AND SALES OF SECURITIES Cost of purchases and proceeds from sales of securities for the six months ended May 31, 1998, excluding short-term investments, aggregated $114,402,081 and $118,229,093, respectively. At May 31, 1998, aggregate gross unrealized appreciation for all securities in which there is an excess of value over cost was $19,542,879 and aggregate gross unrealized depreciation for all securities in which there is an excess of cost over value was $906,095. 20 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- 4. COMMON STOCK At May 31, 1998, 240,000,000 shares of $0.01 par value Common Stock were authorized. There were no Common Stock transactions for the six months ended May 31, 1998 and the year ended November 30, 1997. 5. MONEY MARKET CUMULATIVE PREFERRED(TM) STOCK The Fund's Articles of Incorporation authorize the issuance of up to 10,000,000 shares of $0.01 par value preferred stock. On April 9, 1992, the Fund received proceeds from the public offering of 700 shares of Money Market Cumulative Preferred(TM) Stock of $70,000,000 before offering costs of $144,375 and underwriting discounts and commissions paid directly to Lehman Brothers Inc. of $1,225,000. The Money Market Cumulative Preferred(TM) Stock is senior to the Common Stock and results in the financial leveraging of the Common Stock. Such leveraging tends to magnify both the risks and opportunities to Common Stock Shareholders. Dividends on shares of Money Market Cumulative Preferred(TM) Stock are cumulative. The Fund is required to meet certain asset coverage tests with respect to the Money Market Cumulative Preferred(TM) Stock. If the Fund fails to meet these requirements and does not correct such failure, the Fund may be required to redeem, in part or in full, Money Market Cumulative Preferred(TM) Stock at a redemption price of $100,000 per share plus an amount equal to the accumulated and unpaid dividends on such shares in order to meet these requirements. Additionally, failure to meet the foregoing asset requirements could restrict the Fund's ability to pay dividends to Common Stock Shareholders and could lead to sales of portfolio securities at inopportune times. If the Fund allocates any net gains or income ineligible for the Dividends Received Deduction to shares of the Money Market Cumulative Preferred(TM) Stock, the Fund is required to make additional distributions to Money Market Cumulative Preferred(TM) Stock Shareholders or to pay a higher dividend rate in amounts needed to provide a return, net of tax, equal to the return had such originally paid distributions been eligible for the Dividends Received Deduction. An auction of the Money Market Cumulative Preferred(TM) Stock is generally held every 49 days. Existing shareholders may submit an order to hold, bid or sell such shares at par value on each auction date. Money Market Cumulative Preferred Stock Shareholders may also trade shares in the secondary market between auction dates. At May 31, 1998, 700 shares of Money Market Cumulative Preferred(TM) Stock were outstanding at the annual rate of 4.109%. The dividend rate, as set by the auction process, is generally expected to vary with short-term interest rates. These rates may vary in a manner unrelated to the income received on the Fund's assets, which could have either a beneficial or detrimental impact on net investment income and gains available to Common Stock Shareholders. While the Fund expects to structure the portfolio 21 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- holdings and hedging transactions to lessen such risks to Common Stock Shareholders, there can be no assurance that such results will be attained. 6. PORTFOLIO INVESTMENTS, CONCENTRATION AND INVESTMENT QUALITY The Fund invests primarily in adjustable and fixed rate preferred stocks and similar hybrid securities. Under normal market conditions, the Fund invests at least 25% of its assets in securities issued by utilities and may invest a significant portion of its assets, but less than 25% of its assets, in companies in the banking industry. The Fund's portfolio may therefore be subject to greater risk and market fluctuation than a portfolio of securities representing a broader range of investment alternatives. Because of the Fund's concentration of investments in the utility industry and significant holdings in the banking industry, the ability of the Fund to maintain its dividend and the value of the Fund's investments could be adversely affected by the possible inability of companies in these industries to pay dividends and interest on their securities and the ability of holders of securities of such companies to realize any value from the assets of the issuer upon liquidation or bankruptcy. The Fund may invest up to 15% of its assets at the time of purchase in securities rated below investment grade, provided that no such investment may be rated below both "Ba" by Moody's Investors Service, Inc. and "BB" by Standard & Poor's Rating Group or judged to be comparable in quality at the time of purchase; however, any such securities must be issued by an issuer having an outstanding class of senior debt rated investment grade. The Fund may also invest up to 15% of its assets in common stock. The Fund's investment policy regarding debt securities was amended on July 21, 1995. The amended policy allows the Fund to invest up to 35% of its assets collectively in the following: Trust Originated Preferred Securities ("TOPRS"), Monthly Income Preferred Shares ("MIPS"), Quarterly Income Debt Securities ("QUIDS"), Quarterly Income Preferred Shares ("QUIPS"), Canadian Originated Preferred Securities ("COPRS"), Quarterly Income Capital Securities ("QUICS"), and similarly-structured instruments commonly referred to as hybrid or taxable preferreds, subject to the quality standards set forth above. The Fund's investment policy was further amended on October 17, 1997, to clarify that the foregoing 35% limitation only applies to such TOPRS, MIPS, QUIDS, QUIPS, COPRS, QUICS and analogous securities that the Fund's Adviser deems to be debt-like in key characteristics. 7. SPECIAL INVESTMENT TECHNIQUES The Fund may employ certain investment techniques in accordance with its fundamental investment policies. These may include the use of when-issued and delayed delivery transactions. Securities purchased or sold on a when-issued or delayed delivery basis may be settled within 45 days after the date of the transaction. Such transactions may expose the Fund to credit and market valuation risk greater than that associated with regular trade settlement procedures. The Fund may also enter into transactions, in accordance with its fundamental investment policies, involving any or all of the following: lending of portfolio securities, short sales of securities, futures contracts, options on futures contracts, and options on securities. With the exception of purchasing securities on a when-issued or delayed 22 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- delivery basis or lending portfolio securities, these transactions are used for hedging or other appropriate risk-management purposes or, under certain other circumstances, to increase income. As of May 31, 1998, the Fund owned put options on U.S. Treasury bond futures contracts. No assurance can be given that such transactions will achieve their desired purposes or will result in an overall reduction of risk to the Fund. 23 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated QUARTERLY RESULTS OF INVESTMENT OPERATION (UNAUDITED) - --------------------------------------------------------------------------------
AVAILABLE TO COMMON STOCK SHAREHOLDERS ----------------------------------------------------------------- NET REALIZED NET INCREASE/ AND UNREALIZED (DECREASE) IN NET INVESTMENT GAIN/(LOSS) NET ASSETS FROM INVESTMENT INCOME INCOME ON INVESTMENTS OPERATIONS ------------------- ------------------- -------------------- -------------------- QUARTER PER PER PER PER ENDED TOTAL SHARE* TOTAL SHARE* TOTAL SHARE* TOTAL SHARE* - ------- ----- ------ ----- ------ ----- ------ ----- ------ 02/29/96 $3,672,584 $0.33 $2,333,543 $0.21 $(4,454,117) $(0.40) $(2,120,574) $(0.19) 05/31/96 3,868,154 0.35 2,573,570 0.23 2,444,402 0.22 5,017,972 0.45 08/31/96 3,961,160 0.35 2,661,602 0.24 (716,135) (0.06) 1,945,467 0.18 11/30/96 3,744,137 0.34 2,845,619 0.25 8,647,364 0.77 11,492,983 1.02 02/28/97 3,328,538 0.30 2,789,856 0.25 (233,256) (0.02) 2,556,600 0.23 05/31/97 3,714,170 0.33 3,218,380 0.29 2,151,212 0.19 5,369,592 0.48 08/31/97 3,747,750 0.34 3,195,496 0.29 4,544,355 0.41 7,739,851 0.70 11/30/97 3,653,782 0.33 3,100,290 0.27 3,154,694 0.29 6,254,984 0.56 02/28/98 3,784,203 0.33 3,233,347 0.29 2,711,296 0.24 5,944,643 0.53 05/31/98 3,593,404 0.32 3,028,370 0.27 1,971,753 0.17 5,000,123 0.44
- --------------- * Per share of common stock. 24 - -------------------------------------------------------------------------------- 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 own name will have all distributions reinvested automatically by Investor Services Group as agent under the Plan, unless the shareholder elects to receive cash. Distributions with respect to shares registered in the name of a broker-dealer or other nominee (that is, in "street name") may be reinvested by the broker or nominee in additional shares under the Plan, but only if the service is provided by the broker or nominee, unless the shareholder elects to receive distributions in cash. A shareholder who holds Common Stock registered in the name of a broker or other nominee may not be able to transfer the Common Stock to another broker or nominee and continue to participate in the Plan. Investors who own Common Stock registered in street name should consult their broker or nominee for details regarding reinvestment. The number of shares of Common Stock distributed to participants in the Plan in lieu of a cash dividend is determined in the following manner. Whenever the market price per share of the Fund's Common Stock is equal to or exceeds the net asset value per share on the valuation date, participants in the Plan will be issued new shares valued at the higher of net asset value or 95% of the then current market value. Otherwise, Investor Services Group will buy shares of the Fund's Common Stock in the open market, on the New York Stock Exchange or elsewhere, on or shortly after the payment date of the dividend or distribution and continuing until the ex-dividend date of the Fund's next distribution to holders of the Common Stock or until it has expended for such purchases all of the cash that would otherwise be payable to the participants. The number of purchased shares that will then be credited to the participants' accounts will be based on the average per share purchase price of the shares so purchased, including brokerage commissions. If Investor Services Group commences purchases in the open market and the then current market price of the shares (plus any estimated brokerage commissions) subsequently exceeds their net asset value most recently determined before the completion of the purchases, Investor Services Group will attempt to terminate purchases in the open market and cause the Fund to issue the remaining dividend or distribution in shares. In this case, the number of shares received by the participant will be based on the weighted average of prices paid for shares purchased in the open market and the price at which the Fund issues the remaining shares. These remaining shares will be issued by the Fund at the higher of net asset value or 95% of the then current market value. Plan participants are not subject to any charge for reinvesting dividends or capital gains distributions. Each Plan participant will, however, bear a proportionate share of brokerage commissions incurred with respect to Investor Services Group's open market purchases in connection with the reinvestment of dividends or capital gains distributions. For the year ended May 31, 1998, $4,578 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 25 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - ------------------------------------------------------------------------------ payment date, a dividend or distribution in an amount equal to the cash that the participant could have received instead of shares. In addition to acquiring shares of Common Stock through the reinvestment of cash dividends and distributions, a shareholder may invest any further amounts from $100 to $3,000 semi-annually at the then current market price in shares purchased through the Plan. Such semi-annual investments are subject to any brokerage commission charges incurred. A shareholder whose Common Stock is registered in his or her own name may terminate participation in the Plan at any time by notifying Investor Services Group in writing, by completing the form on the back of the Plan account statement and forwarding it to Investor Services Group or by calling Investor Services Group directly. A termination will be effective immediately if notice is received by Investor Services Group not less than 10 days before any dividend or distribution record date. Otherwise, the termination will be effective, and only with respect to any subsequent dividends or distributions, on the first day after the dividend or distribution has been credited to the participant's account in additional shares of the Fund. Upon termination and according to a participant's instructions, Investor Services Group will either (a) issue certificates for the whole shares credited to the shareholder's Plan account and a check representing any fractional shares or (b) sell the shares in the market. Shareholders who hold common stock registered in the name of a broker or other nominee should consult their broker or nominee to terminate participation. The Plan is described in more detail in the Fund's Plan brochure. Information concerning the Plan may be obtained from Investor Services Group at 1-800-331-1710. 26 - -------------------------------------------------------------------------------- Preferred Income Opportunity Fund Incorporated ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) ------------------------------------------------------------------------------ MEETING OF SHAREHOLDERS On April 17, 1998, the Fund held its Annual Meeting of Shareholders (the "Meeting") to (1) elect two Directors of the Fund ("Proposal 1"), (2) ratify the selection of Coopers & Lybrand L.L.P. as independent accountants for the Fund for the fiscal year ending November 30, 1998 ("Proposal 2"), and (3) approve an amendment to the Fund's Articles of Incorporation to require a "super-majority" vote to change the Fund's investment objective, its diversified status or its policy against investing for the purpose of gaining control of a company ("Proposal 3"). With respect to Proposal 3, the Meeting was adjourned and reconvened on May 15, 1998. The results of each proposal are as follows: PROPOSAL 1: ELECTION OF DIRECTORS.
NAME FOR WITHHELD UNVOTED - ---- --- -------- ------- Common Stock Robert F. Wulf............................................ 10,146,455 316,950 -- Preferred Stock Donald F. Crumrine........................................ 559 -- --
Martin Brody, Robert T. Flaherty, David Gale and Morgan Gust continue to serve in their capacities as Directors of the Fund. PROPOSAL 2: RATIFY THE SELECTION OF COOPERS & LYBRAND L.L.P. AS INDEPENDENT ACCOUNTANTS.
FOR AGAINST ABSTAINED --- ------- --------- Common Stock and Preferred Stock (voting together as a single class) Voted....................................................... 10,263,778 41,334 158,853
PROPOSAL 3: APPROVE AN AMENDMENT TO THE FUND'S ARTICLES OF INCORPORATION.
FOR AGAINST ABSTAINED --- ------- --------- Common Stock and Preferred Stock (voting together as a single class) Voted....................................................... 5,888,356 345,306 234,079 Preferred Stock (voting as a separate class) Voted....................................................... 436 0 23
27 DIRECTORS Martin Brody Donald F. Crumrine, CFA Robert T. Flaherty, CFA David Gale Morgan Gust Robert F. Wulf, CFA OFFICERS Robert T. Flaherty, CFA Chairman of the Board and President Donald F. Crumrine, CFA Vice President and Secretary Robert M. Ettinger, CFA Vice President Peter C. Stimes, CFA Vice President and Treasurer Carl D. Johns Assistant Treasurer INVESTMENT ADVISER Flaherty & Crumrine Incorporated e-mail: flaherty@westworld.com QUESTIONS CONCERNING YOUR SHARES OF 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 -- First Data Investor Services Group, Inc. P.O. Box 1376 Boston, MA 02104 1-800-331-1710 THIS REPORT IS SENT TO SHAREHOLDERS OF PREFERRED INCOME 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. 3202 4/98 [Preferred Income Opportunity] Semi-Annual Report May 31, 1998 -----END PRIVACY-ENHANCED MESSAGE-----