Annual Report
November 30, 2020

Flaherty & Crumrine Dynamic Preferred and Income Fund

To the Shareholders of Flaherty & Crumrine Dynamic Preferred and Income Fund (“DFP”):

Fiscal 2020 came to an end on November 30, 2020, closing out quite a year for preferred and income securities. Total return¹ on net asset value (“NAV”) was 5.5% for the fourth fiscal quarter² and 8.9% for the full fiscal year. Total return on market price of Fund shares over the same periods was 8.3% and 14.9%, respectively.

(1)Since inception on May 29, 2013.

(2)The Bloomberg Barclays U.S. Aggregate Index is an unmanaged index considered representative of the U.S. investment grade, fixed-rate bond market.

(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.

Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results. In addition, NAV performance will vary from market price performance, and you may have a taxable gain or loss when you sell your shares.

2020 will go down as a year many would like to forget, with uneven economic, social, and personal fortunes and misfortunes experienced by so many. We are all hoping for a swift end to COVID-19 and related suffering. Markets are ending 2020 well out ahead of this healing process, looking forward to effective vaccines and a return to economic health – supported by continued accommodative monetary policy.

Investors won’t soon forget the wild ride that started in March and continued (thankfully, in a positive direction) for the balance of the year. Much of the market’s early selloff was driven by fear and uncertainty, and market technicals (particularly deleveraging) accelerated the decline. There are, however, a few important factors firmly behind the Fund’s performance, the market rebound and a continued rally in preferreds and contingent-capital (“CoCo”) securities. We believe many of those factors will continue into next year.

Credit quality remains a bright spot within most sectors that issue preferreds – most notably financials. Not all issuers are created equal, but in general banks and other financial issuers have been out in front of loan losses related to COVID-19 – adding aggressively to reserves while adjusting operations to continue serving customers and earning a profit. Not all borrowers will be able to meet their loan obligations, but we believe banks have strong balance sheets and will continue to be a source of strength for the broader economy. Loan losses generally have been absorbed within ongoing earnings and do not appear to threaten capital. Energy was a difficult sector for most of the year but rebounded nicely in the fourth fiscal quarter as investors gained confidence in these credits and enjoyed some of the highest yields available in preferreds. Financials and energy were 85.8% and 6.4% of the portfolio, respectively, as of November 30, 2020.

¹Following the methodology required by the Securities and Exchange Commission, total return assumes dividend reinvestment.

²September 1, 2020 – November 30, 2020

Compared to the start of 2020, interest rates moved materially lower and are forecast to remain near these levels for several years. Declining interest rates had a large impact on most fixed-income securities, including preferreds and CoCos. Interest-rate duration varies among individual preferreds and CoCos, and longer duration securities certainly outperformed shorter duration. However, the real impact of low rates on our market has been on all-in yields and a corresponding compression in spreads. As Treasury rates moved lower, fixed-income yields moved lower as well – and preferreds/CoCos, offering a spread to Treasuries in excess of investment-grade corporate bonds, benefited greatly from this compression. We’ve referred to this before as a global search for yield, and this search accelerated as U.S. interest rates declined materially. (Many global rates were already low, so the U.S. compressed relative to other markets.) With business and consumer spending down as a result of the pandemic, savings are up, and investors have cash that needs to be invested. Yield is difficult to find in a low-rate environment, and preferreds/CoCos continue to offer a yield advantage over many alternatives.

A discussion of lower interest rates and economic recovery isn’t complete without acknowledging the important role of the Federal Reserve. Beginning in March, the Fed quickly resurrected the emergency credit and liquidity facilities it used in the financial crisis of 2008-2009. In addition, it aggressively eased monetary policy through both lower short-term rates and quantitative easing (i.e., securities purchases). This time around, it added direct investments in both investment-grade (IG) and high yield (HY) corporate bonds – with ETFs as a primary investment vehicle. In addition to factors mentioned above, this also led to a “pile-on” trade in these markets as investors followed the Fed’s lead. It is difficult to measure the impact directly, but there’s little question the Fed’s actions were important factors in improving investor confidence.

Taken as a whole, the Fund’s portfolio performed very well this fiscal year – certainly better than anyone imagined back in March/April. We raised cash and reduced portfolio risk proactively during those early weeks but did not reduce leverage balances during the year. The Fund’s ability to redeploy that cash as markets rebounded proved very beneficial. Distributions to shareholders were raised twice during the year, reflecting the benefits of resilient portfolio income and lower leverage costs.

The portfolio remains concentrated in financials, which is consistent with our view of ongoing credit strength there. We continue to value call protection and current income, as they allow better control over reinvestment decisions and more stable distributions to shareholders. Nonetheless, there is a trade-off for the Fund’s strong total return this year. As benchmark interest rates fell and credit spreads narrowed, prices rose but reinvestment yields declined. This is a natural part of fixed-income markets, but it does likely mean a trend toward lower coupons as issuers refinance older, higher-coupon securities when they become callable. Lower reinvestment yields put downward pressure on portfolio income over time, and with short-term rates already near zero, there is not much room for lower leverage cost to offset it.

Economic recovery will be uneven across sectors and regions, as COVID-19 continues to be a new and challenging virus, but we are at least beginning to turn a corner with vaccine production and distribution. We believe most preferred and CoCo issuers entered this latest crisis on solid footing and have taken steps necessary to weather this storm, but much uncertainty remains over the pace and extent of global recovery. In the meantime, we continue to monitor credits and security valuations closely and work to position the Fund’s portfolio to meet its objectives. We continue to see opportunity in the preferred and CoCo markets, especially from the viewpoint of long-term income investors.

Sincerely,

The Flaherty & Crumrine Portfolio Management Team

December 31, 2020

For the six months and one year periods ended November 30, 2020, the ICE BofA 8% Constrained Core West Preferred & Jr Subordinated Securities Index^SM (P8JC)¹ returned 9.4% and 7.5%, respectively. This index reflects the various segments of the preferred securities market constituting the Fund’s primary focus. Since this index return excludes all expenses and the impact of leverage, it compares most directly to the top line in the Fund’s performance table above (Total Return on Unleveraged Securities Portfolio).

Total Return on Market Price of Fund Shares

While our focus is primarily on managing the Fund’s investment portfolio, a shareholder’s actual return is comprised of the Fund’s monthly dividend payments plus changes in the market price of Fund shares. During the twelve-month period ended November 30, 2020, total return on market price of Fund shares was 14.9%.

Historically, the preferred securities market has experienced price volatility consistent with those of other fixed-income securities. However, since mid-2007 it has become clear that preferred-security valuations can move dramatically when there is volatility in financial markets. This volatility can lead to swings in both the NAV and market price of Fund shares. The chart below contrasts the relative stability of the Fund’s earlier period with the more recent volatility in both its NAV and market price. Many fixed-income asset classes experienced increased volatility over this period.

¹The ICE BofA 8% Constrained Core West Preferred & Jr Subordinated Securities Index (P8JC) includes U.S. dollar-denominated investment-grade or below investment-grade, fixed rate, floating rate or fixed-to-floating rate, retail or institutionally structured preferred securities of U.S. and foreign issuers with issuer concentration capped at 8%. All index returns include interest and dividend income, and, unlike the Fund’s returns, are unmanaged and do not reflect any expenses.

In a more perfect world, the market price of Fund shares and its NAV, as shown in the above chart, would track more closely. If so, any premium or discount (calculated as the difference between these two inputs and expressed as a percentage) would remain relatively close to zero. However, as can be seen in the chart below, this often has not been the case.

Although divergence between NAV and market price of a closed-end fund is generally driven by supply/demand imbalances affecting its market price, we can only speculate about why the relationship between the Fund’s market price and NAV hasn’t been closer.

Based on a closing price of $29.06 on December 31^st and assuming its current monthly distribution of $0.165 does not change, the annualized yield on market price of Fund shares is 6.8%. Of course, there can be no guarantee that the Fund’s dividend will not change based on market conditions.

U.S. Economic and Credit Outlook

Like financial markets, the U.S. economy had a rollercoaster year in 2020. The COVID-19 pandemic and public and private responses to it dealt a severe blow to the economy in the first half of 2020. Safer-at-home orders that began in March prompted many businesses to suspend or sharply reduce operations; a recession began that month. Most of those businesses began to reopen in May, prompting a strong, albeit uneven, recovery in the second half of the year. Today, many businesses are coping with renewed restrictions – or simply more cautious consumer behavior – as COVID-19 cases multiplied in the last several months of the year, clouding the near-term economic outlook.

Nonetheless, the economy exited 2020 in a substantially better position than seemed possible last spring. Inflation-adjusted gross domestic product (real GDP) fell 5.0% in the first quarter of 2020 as the pandemic unfolded, plunged 31.4% in Q2 on unprecedented steps to slow its spread, and rebounded 33.4% in Q3 as the economy reopened. Those swings in Q2 and Q3 were by far the largest since quarterly GDP statistics began in 1947. Economists forecast² 4.5% real GDP growth in Q4, which still would leave the economy about 2.3% smaller than its level in 4Q2019. Looking ahead, economists expect 4.0% real growth in 2021, with a sluggish first quarter followed by solid expansion over the remainder of the year as vaccines accelerate progress against COVID-19.

After reaching a 50-year low of 3.5% in late 2019, the unemployment rate surged to a high of 14.7% in April 2020. It ended the year at 6.7%. From a peak level of 152.5 million nonfarm payroll jobs in February 2020, employment fell by 22.2 million jobs in just two months before gradually climbing back to 142.6 million in December, although that means nearly 10 million job losses since the start of the pandemic. Moreover, total payroll jobs are roughly 12 million below where they would have been if job growth continued at its prior rate of about 1.5%. There is still a long way to go before employment fully recovers from the pandemic.

Higher wages offset some of the pain for those who remained employed, and jobless benefits and other transfer payments provided needed support for those who lost jobs. As a result, real disposable personal income rose 3.1% over 12 months ending in November 2020 (latest data available). However, with many activities curtailed, real personal spending fell 2.4% over the same period. Higher income and lower spending pushed the average personal savings rate up to a record 15.7% over 12 months ending in November. Although some individuals are experiencing significant financial hardship, aggregate consumer balance sheets are in very good shape. Consumer spending is likely to remain cautious in Q1, but warmer weather and wider availability of coronavirus vaccines should prompt a rebound in consumer spending over the balance of 2021.

Investment spending was mixed in 2020. Business investment rose strongly in the third quarter (+22.9%), but it remains 4.4% below its 4Q2019 level, mostly due to lower nonresidential construction. Office building occupancy remains low, which drove a 14.8% drop (not annualized) in investment in nonresidential structures since 4Q2019. In contrast, residential investment boomed in 2020. It was up at a 63% pace in Q3 and is 5.7% above its 4Q2019 level. However, because residential investment is only ¼ the size of business investment, overall investment spending remains down a little more than 2% since 4Q2019. Looking ahead, business investment should pick up gradually as excess capacity declines with economic recovery; residential investment – fueled by rising wages, low mortgage interest rates and migration from high-density urban to lower-density environments – should remain strong in 2021, albeit below Q3’s torrid pace.

²Unless noted otherwise, forecasts are from Bloomberg^® L.P., U.S. Monthly Economic Survey, December 11, 2020.

Government spending performed its usual countercyclical role during a recession. Government consumption rose 1.3% and 2.5% in Q1 and Q2, respectively, as other sectors contracted. Spending slipped 4.8% in Q3 as GDP elsewhere recovered. At the federal level, the entire jump in spending was deficit-financed, pushing the budget deficit for 12 months ended in November 2020 to $3.2 trillion on $6.6 trillion in spending, which was up 47% from the same period a year earlier. A sharp increase in private savings and the Federal Reserve’s balance sheet expansion made that debt easy to finance, although federal government debt-to-GDP rose more than 20 percentage points to end Q3 at almost 109%. This is not a near-term worry, but it has longer-term implications for economic growth and could limit fiscal options over coming years.

Inflation slowed as the economy fell into recession. The personal consumption expenditures deflator excluding food and energy touched a low of 1.2% year-over-year in June and edged up to 1.6% as of November 2020, well below the Fed’s 2% inflation target. Economic recovery should close the gap between current and potential economic growth, pushing inflation upward, although global excess capacity could make this a slow process.

As noted in our opening shareholder letter, monetary policy eased vigorously at the onset of the pandemic and has remained highly accommodative given outlooks for employment and inflation. The Federal Reserve cut the federal funds rate target by 1.5% to nearly zero in 2020; it forecasts no change through 2023. Moreover, the Fed’s balance sheet grew from about $4.2 trillion in February to nearly $7.4 trillion at year-end 2020, leaving markets awash in liquidity. Money supply growth surged, with M1 and M2 up 67% and 25%, respectively, at year-end 2020 compared to a year earlier. While probably not a significant risk for 2021, that could fuel a quicker rise in inflation than the Fed currently expects as the pandemic recedes.

Credit conditions worsened sharply as the economy entered a recession in March, but fiscal and monetary responses along with a flattening of the coronavirus infection curve and strong economic recovery in Q3 led to a rapid improvement from April onwards. Although bankruptcy filings increased notably in 2020, bank loan problems have remained modest. Most U.S. banks roughly doubled loan-loss reserves relative to nonperforming loans in 2020, in expectation of significant credit deterioration. For the most part, that has not materialized. Consumer loan charge-offs and delinquencies were 1.9% and 1.8%, respectively, in Q3 (latest data available), down about 0.4% from 4Q2019. Commercial and industrial loan problems did increase, with Q3 charge-offs and delinquencies at 0.55% and 1.9%, respectively, but that is only about 0.2% higher than in 4Q2019. There is little doubt that some of these borrowers will default in 2021, but so far, most U.S. banks have not experienced a spike in loan defaults.

At the same time, banks reduced payments to shareholders, with steady or lower dividends and little to no share repurchases since the first quarter, all while making respectable profits. As a result, despite significantly increasing loan-loss reserves, banks’ capital ratios improved substantially in 2020. Capital and reserve strength was evident in a second round of stress tests that the Federal Reserve conducted on the nation’s largest banks. From an average starting common equity Tier 1 (“CET1”) ratio of 12.2%, the average ratio fell to 9.6-9.7% under severe economic assumptions used in the tests, a smaller decline than in earlier tests, due to larger loan-loss reserves, and well above the 4.5% minimum set by the Fed. Moreover, no bank in the exercise failed its stress tests. We think these results highlight the major improvement in bank credit quality since the financial crisis, and we remain confident owning their preferred securities.

Although not all sectors look as good as banks, insurance and other financial services, utilities and communications businesses remain broadly healthy. Even energy companies, which seemed at risk as economic activity plummeted in Q2, revived along with a brighter economic outlook over the past quarter.

We see risk from the pandemic receding in 2021, leading to above-trend growth with low but gradually rising inflation: in short, a favorable credit environment. After a sustained rally since the lows in March 2020, credit spreads reflect that optimistic view. That means credit selection will be of paramount importance, and it remains at the heart of the Fund’s investment process. As we said to close our shareholder letter, we continue to see opportunity in the preferred and contingent capital securities markets.

Where’s my Printed Report? (Electing Delivery Preferences)

The Securities and Exchange Commission (“SEC”) in recent years made substantial changes to reporting requirements for closed-end investment companies such as the Fund. Among those changes is the option for funds to save on printing and mailing costs by providing electronic access to shareholder reports and notice of their availability. The Fund is no longer required to mail printed shareholder reports unless the shareholder specifically requests a paper copy. Under the new rules, which the Fund adopted with this report, shareholders fall into one of three groups.

1.Shareholders who have requested electronic delivery of the report (“edelivery”), either directly from their financial intermediary (if holding shares in “street name” in a brokerage account) or from the Fund (if holding “registered shares” at BNY Mellon/Computershare, the Fund’s transfer agent). When you sign up for edelivery, you will receive an email notification and a weblink to the shareholder report when it is available. If you already elected edelivery, you will not be affected by the new rule and you need not take any action.

2.Shareholders who have requested a printed shareholder report. Once again, this can be done either directly through your financial intermediary or from the Fund (if holding registered shares). Shareholders requesting a printed report will receive it via postal mail.

3.All other shareholders will receive mailed notice that a report is available, along with a web address where it can be accessed via the internet.

Please note, most shareholders hold shares in street name in their brokerage account (rather than registered shares) and should select their delivery preference with their financial intermediary.

We encourage shareholders to choose edelivery. You will receive reports sooner than via postal mail. It’s better for the environment. And it saves the Fund money; printing and mailing reports is expensive, and shareholders bear those expenses. Nonetheless, if you want a printed report, you may request it at no cost to you.

We would also like to minimize mailed notices. It seems wasteful to mail a piece of paper whose purpose is to direct you to your web browser. If you want to access reports electronically, please sign up for edelivery and skip the extra step – and added cost to your Fund – of mailed notices.

Summarizing how to specify your delivery preferences:

If you hold Fund shares in your brokerage account (most shareholders) and have not already selected your delivery preferences, contact your financial intermediary and request edelivery or printed reports. If you received a mailed notice, specific instructions are printed there.

If you hold shares at the Fund’s transfer agent, BNY Mellon/Computershare, and have not already selected your delivery preferences, contact the transfer agent and request edelivery or printed reports by telephone at 1-866-351-7446 (U.S. toll-free) or +1 (201) 680 6578 (International) or postal mail at BNY Mellon c/o Computershare, P.O. Box 505000, Louisville, KY, 40233-5000, United States.

You may change your delivery preferences at any time. There is no cost to you for either delivery option. In general, elections will apply to all funds held in your account at that financial intermediary. Likewise, your election to receive reports in paper will apply to all funds held with the fund complex if you invest directly with the Fund.

Thank you for taking the time to make your delivery election!

Federal Tax Advantages of 2020 Calendar Year Distributions

In calendar year 2020, approximately 85.9% of distributions made by the Fund was eligible for treatment as qualified dividend income, or QDI. Depending on an individual’s level of income, QDI can be taxed at a rate of 0%, 15% or 20%.

For an individual in the 32% marginal tax bracket, this means that the Fund’s total distributions will only be taxed at a blended 17.4% rate versus the 32% rate which would apply to distributions by a fund investing in traditional corporate bonds. This tax advantage means that, all other things being equal, for every $100 distribution that such individual receives from the Fund for the calendar year, the same individual would have had to receive approximately $121 in distributions from a fully-taxable bond fund to net the same after-tax amount as the distributions paid by the Fund.

For detailed information about tax treatment of 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 37.6% of distributions that were eligible for the inter-corporate dividends received deduction, or DRD.

It is important to remember that composition of the portfolio and income distributions can change from one year to the next, and that the QDI or DRD portions of 2021’s distributions may not be the same (or even similar) to 2020.

Flaherty & Crumrine Dynamic Preferred and Income Fund Incorporated

PORTFOLIO OF INVESTMENTS

November 30, 2020 

Flaherty & Crumrine Dynamic Preferred and Income Fund Incorporated

STATEMENT OF ASSETS AND LIABILITIES

November 30, 2020

Flaherty & Crumrine Dynamic Preferred and Income Fund Incorporated

STATEMENT OF OPERATIONS

For the Year Ended November 30, 2020

†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.

Flaherty & Crumrine Dynamic Preferred and Income Fund Incorporated

STATEMENT OF CASH FLOWS

For the Year Ended November 30, 2020