FLAHERTY & CRUMRINE dynamic PREFERRED and INCOME FUND

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

Fixed-income investors shifted into a more defensive position during the quarter, which contributed to modest weakness in preferred securities prices. Total return¹ on net asset value (“NAV”) was -2.0% for the fiscal quarter² and -2.6% for the first half of the fiscal year. Total return on market price of Fund shares over the same periods was -4.9% and -10.0%, respectively.

The table below shows Fund NAV returns over various measurement periods. The table includes performance of two indices, Bloomberg Barclays U.S. Aggregate and S&P 500, as proxies for bond and stock markets, respectively. While neither is a benchmark for Fund performance, they provide context for returns on broad asset categories.

Interest rates are a top concern for many investors, and we often receive questions about the performance of preferred securities in a rising-rate environment. Preferred securities’ prices normally decline when Treasury yields rise; i.e., they have positive “duration.” However, our investments in fixed-to-float structures (which pay a fixed distribution rate for a set period then float at a spread over a benchmark yield) greatly reduces portfolio duration compared to a portfolio comprised of mostly fixed-rate securities. As of May 31, 2018, 84% of the portfolio was invested in fixed-to-float or currently-floating securities. A dozen years ago, the preferred market was dominated by fixed-rate securities, often with long interest rate durations, and some investors still think of preferreds as being highly sensitive to Treasury yields. Today, with fixed-to-float and floating rate preferred securities having become more common, there are many short-and intermediate-duration preferred securities available.

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

²March 1, 2018 – May 31, 2018

One may expect yields to be considerably lower on fixed-to-float securities compared to fixed-rate securities, but this generally has not been the case. Investors continue to receive attractive yields on preferred securities even though duration is moderate – and issuer credit quality generally is in excellent shape. Higher Treasury yields may dampen preferred returns over the next year or two, but over a longer time horizon, total returns should remain more than competitive with fixed-income alternatives.

While the Federal Reserve raised its benchmark rate as expected in March and June, shareholders may be surprised that 10-year and 30-year Treasury yields actually ended lower on May 31 (2.82% and 2.99%, respectively) compared to February 28 (2.87% and 3.13%, respectively), although higher rates persisted for much of the second fiscal quarter. Investors shifted into more defensive interest-rate positions, resulting in relative underperformance of 10-year fixed-to-float securities compared to five-year and shorter issues. This was in response to an improving economic outlook across the globe, a flattening yield curve, and anticipation of additional Federal Reserve rate increases in the future.

Rates were not the only reason for defensive positioning, as can be seen by lower Treasury yields at quarter-end. Political risks arose once again, with instability in Spain and Italy prompting weakness in foreign preferreds and increased trade rhetoric (and tariff actions) causing concern about possible negative effects on global economic growth and credit quality.

Preferred prices were also negatively affected during the quarter by new-issue supply. Supply has not been overwhelming, but issuers needed to offer yield concessions to entice buyers – and new-issue yield concessions put downward pressure on secondary market prices. We view this as an opportunity to invest proceeds of called securities at significantly higher yields, which should contribute positively to performance over time. Recall it wasn’t long ago we were writing about 4-handle preferred coupons, but those same issuers today are pricing new securities in the mid- to high-5% area, and yields have reached 7% for issuers in some industries. This is welcome relief from the low-yield environment experienced in recent years.

No particular segment of the portfolio stood out during the quarter, as modest weakness was broad-based and macro in nature. It is worth noting once again that issuer credit quality remains in great shape and should be supportive even in light of higher rates and political uncertainty. A number of non-financial industries are increasing leverage for operational purposes or acquisitions, but for the most part they are not regular issuers of preferred securities. We continue to position the portfolio with an emphasis on credit quality and security-specific structure (e.g., fixed-to-float for moderate interest-rate risk, call protection for income stability), and we are taking advantage of higher yields on new-issue preferred securities.

We are all familiar with the certainty of taxes, but it seems like many investors have moved away from evaluating investments on an after-tax basis – and to their detriment when it comes to preferred securities. In fairness, qualified dividend income (QDI) was an elusive concept for many years, as it was new for individuals in 2003 and initially subject to sunset provisions. However, it was made permanent in 2012 and offers a tremendous benefit to U.S. individuals receiving QDI. Evaluating investments solely on a pre-tax basis certainly makes comparisons across markets much simpler, but “simple” often translates into missed opportunity.

In taxable accounts, QDI can result in a gross-up factor as high as 1.287³ versus pre-tax yields – meaning a 6.0% pre-tax yield, for example, is 7.72% on a taxable-equivalent basis. We have witnessed a multi-year shift in investor awareness away from investment tax considerations, resulting in almost no yield difference between tax-advantaged and fully-taxable preferreds (both types are issued) – which implies the QDI benefit is largely underappreciated. In calendar 2017, 81.8% of DFP’s distributions were QDI-eligible (as reported on Form 1099, box B). For illustration, a market yield of 7.0%⁴ on DFP (higher than the 6.0% used above due to the Fund’s use of leverage) would be a taxable-equivalent yield of 8.6% (assuming 81.8% QDI). Although distribution rates and QDI composition do change each year, shareholders should be aware that QDI is an important benefit of investing in preferred securities and should not be ignored.

We encourage you to read the discussion topics that follow, as we dig deeper into subjects of interest to shareholders – including leverage costs and distribution rates. In addition, visit the Fund’s website, www.preferredincome.com, for timely and important information.

Sincerely,

The Flaherty & Crumrine Portfolio Management Team

June 30, 2018

³Assumes marginal tax bracket of 37% and 3.8% Medicare tax on investment income.

⁴Market yields vary with changes in distribution rates and market price of Fund shares. 7.0% used for illustration purposes only. Investors should consult their tax advisors regarding their personal situation.

DISCUSSION TOPICS

(Unaudited)

The Fund’s Portfolio Results and Components of Total Return on NAV

The table below presents a breakdown of the components that comprise the Fund’s total return on NAV over the recent six months. These components include: (a) the total return on the Fund’s portfolio of securities; (b) any returns from hedging the portfolio against significant increases in long-term interest rates; (c) the impact of utilizing leverage to enhance returns to shareholders; and (d) the Fund’s operating expenses. When all of these components are added together, they comprise the total return on NAV.

Components of DFP’s Total Return on NAV
for the Six Months Ended May 31, 2018¹

For the six months ended May 31, 2018 the ICE BofAML 8% Constrained Core West Preferred & Jr Subordinated Securities Index^SM (P8JC)^1,2 returned -0.9%. 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, our shareholders’ actual return is comprised of the Fund’s monthly dividend payments plus changes in the market price of Fund shares. During the six-month period ending May 31, 2018, total return on market price of Fund shares was -10.0%.

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, including both the Fund’s NAV and the market price of its shares, can move dramatically when there is volatility in financial markets. 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 BofAML 8% Constrained Core West Preferred & Jr Subordinated Securities Index^SM (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.

²The benchmarks from ICE Data Indices, LLC (“ICE Data”) are used with permission. ICE Data, its affiliates and their respective third party suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the indices, index data and any data included in, related to, or derived therefrom. Neither ICE Data, its affiliates nor their respective third party providers shall be subject to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the indices or the index data or any component thereof, and the indices and index data and all components thereof are provided on an “as is” basis and your use is at your own risk. ICE Data, its affiliates and their respective third party suppliers do not sponsor, endorse, or recommend Flaherty & Crumrine Incorporated, or any of its products or services.

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 $23.46 on June 29^th and assuming its current monthly distribution of $0.148 does not change, the annualized yield on market price of Fund shares is 7.6%. Of course, there can be no guarantee that the Fund’s dividend will not change based on market conditions.

Monthly Distributions to Fund Shareholders

So far in 2018, the Federal Reserve has continued its pattern of gradually raising the federal funds rate – hiking 0.25% in both March and June. The Fed now has a target range of 1.75-2.0%. Further, Federal Open Market Committee (FOMC) members project two more 25 bp rate increases in 2018. Including the increase in December 2017, the total increase during the Fund’s fiscal year has been 0.75%.

In response, short-term interest rates have risen to reflect actual and expected increases in the Fed’s target. The Fund’s cost of leverage is linked to 1-month LIBOR. The average cost of leverage was 2.0% for fiscal 2017 and 2.5% for the first half of fiscal 2018. The most recent reset of its leverage rate on June 18, 2018 (actual resets occur monthly) brought the current rate to 2.9%.

Changes in leverage cost and top-line portfolio income are incorporated into the Fund’s dividend-setting process and are also a normal part of the way credit markets function. Interest rates are not static, and neither are credit spreads. The portfolio is designed to have a wide range of coupons, call protection, and security structures – and each aspect will change over time. We seek to maintain call protection that staggers the impact of changes in interest rates and credit spreads, but the portfolio will normally contain at least
some securities subject to being called based on current market conditions. Leverage is utilized in the Fund to increase income and returns to shareholders, and leverage continues to enhance distributable income, even though its cost has increased.

The primary objective of the Fund is total return, with an emphasis on high current income, and we believe the Fund will continue to meet that objective – although distributable income may be reduced as we proceed through this economic cycle. Reductions are simply a reflection of changes in interest rates and credit spreads that have cumulated over time. However, relative to fixed-income alternatives, the level of income produced should remain attractive. Fund shareholders have benefited from years of record-low interest rates and low leverage costs, but rates are moving back into balance as economic growth has improved. We believe the Fund’s strategy of investing in preferred securities and using leverage in an efficient manner will continue to produce a competitive distribution rate for shareholders.

U.S. Economic and Credit Outlook

The U.S. economy expanded by 2.0% in the first calendar quarter of 2018, considerably below an average 3% growth rate during the prior nine months. However, inflation-adjusted gross domestic product (real GDP) is expected to rebound to 3.3% in the second quarter, and economists forecast continued solid real GDP growth of 2.9% in 2018 and 2.5% in 2019.³ Those forecasts are consistent with our own.

³Unless noted otherwise, forecasts are from the Bloomberg^® U.S. Monthly Economic Survey, June 8, 2018.

There are four key expectations underlying our outlook.⁴ First, tax reform should prompt greater business investment and boost labor productivity. Second, higher wages due to a shrinking pool of available workers should support income growth above 4%, even as job growth slows as the economy reaches full employment. Third, global economic activity – which expanded by 3.8% in 2017 – should remain near that level in 2018. Finally, we assume that immigration and trade policies do not lead to worker shortages or trade wars that damage U.S. and global growth.

With the first half of 2018 behind us, we feel confident in the first three views, but we are considerably less confident on trade and immigration policies. We cannot predict what direction trade negotiations will take or their impact on U.S. economic growth, but with tariff barriers now expanding in the U.S. and abroad, economic risks are skewed to the downside. Immigration policy appears similarly unpredictable. We still think an optimistic economic outlook remains warranted, but risks have increased.

Inflation at last reached the Federal Reserve’s target in May, when the personal consumption expenditure deflator excluding food and energy prices hit 2.0% YoY. Rising wages, higher home and energy prices and, now, tariffs on some imported goods are likely to push inflation higher. However, we think this will be a gradual process that will not prompt the Fed to tighten monetary policy more rapidly.

In response to good economic growth and higher inflation, the Federal Reserve hiked rates by 25 bp in March and again in June, bringing the target federal funds rate to 1.75-2.00% currently. The Fed also continued to wind down its securities holdings at a rate of $30 billion per month in Q2; it is slated to rise to $50 billion per month in Q4 and beyond. Ten- and 30-year Treasury rates pushed higher in the first two months of 2018 but have been range-bound since then, closing at 2.86% and 2.99%, respectively, on June 29.

After a recent decline in Treasury yields, our current rate expectations are a little above market forward rates but below the Fed’s median forecast of a 3.4% federal funds rate for year-end 2020. We expect that solid economic growth in 2018 and 2019 will moderate in 2020 as federal government spending slows and early stimulus from tax reform wanes. In addition, rising Treasury supply and reduced portfolio reinvestment by the Fed should combine with prior rate hikes to tighten financial conditions without more aggressive monetary tightening. As a result, we think intermediate Treasury rates will rise only moderately from current levels – perhaps by 50 bp or so over the next several years – although they could be more volatile than in recent years.

Credit spreads on preferred securities and investment-grade corporate bonds widened as investors worried about rising global trade tensions and a renewed swing toward populist economic policies in the U.S. and abroad. While we acknowledge those challenges, credit fundamentals – especially at U.S. financial companies – continue to support preferred securities. Bank capital in the U.S. is strong and stable; loan performance is steady to improving overall; loan-loss reserves are sizable; and earnings, even before accounting for tax reform, are rising. Moreover, all banks that participated in the Federal Reserve’s recent Dodd-Frank Act Stress Tests (DFAST) and Comprehensive Capital Analysis and Review (CCAR) passed the quantitative portions of those regulatory reviews, and the Fed objected to just one bank’s capital plan on a qualitative basis.⁵ Other industries have also benefitted from stronger growth. Higher investment yields are boosting returns at insurance companies. Increased demand for oil and gas is benefitting pipeline companies that bring those resources to market. And sturdy hiring and rising incomes support a range of businesses from REITs to homebuilders to manufacturers.

⁴First-Quarter U.S. Economic Update, Flaherty & Crumrine Incorporated, May 15, 2018. Available at www.flaherty-crumrine.com and the Fund’s website.

⁵The Fed objected to DB USA Corporation’s capital plan due to qualitative concerns over its capital planning and DFAST processes.

For preferred investors, we see this outlook as good news following modestly negative returns since the start of 2018. Credit fundamentals are strong, especially at financial institutions, and solid economic growth and rising profits should support credit spreads. Although short rates are likely to rise further and markets will face ongoing trade and political uncertainty, we think most of the adjustment in intermediate- and long-term interest rates has already occurred. We believe the macroeconomic and credit environments remain supportive of preferred securities.

^§Date shown is maturity date unless referencing the end of the fixed-rate period of a fixed-to-floating rate security.

*Securities eligible for the Dividends Received Deduction and distributing Qualified Dividend Income.

**Securities distributing Qualified Dividend Income only.

***Aggregate cost of securities held.

****Securities exempt from registration under Rule 144A of the Securities Act of 1933. These securities may be resold in transactions exempt from registration to qualified institutional buyers. At May 31, 2018, these securities amounted to $216,502,601 or 29.9% of total managed assets.

⁽¹⁾All or a portion of this security is pledged as collateral for the Fund’s loan. The total value of such securities was $438,061,976 at May 31, 2018.

⁽²⁾Foreign Issuer.

⁽³⁾Represents the rate in effect as of the reporting date.

‡The percentage shown for each investment category is the total value of that category as a percentage of total managed assets.

​ABBREVIATIONS:

3ML—3-Month ICE LIBOR USD A/360

ISDA5—5-year USD ICE Swap Semiannual 30/360

SW5—5-year USD Swap Semiannual 30/360

SW10—10-year USD Swap Semiannual 30/360

T10Y—Federal Reserve H.15 10-Yr Constant Maturity Treasury Semiannual yield

†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.

⁽¹⁾May include income earned, but not paid out, in prior fiscal year.

Contained below is per share operating performance data, total investment returns, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements and market price data for the Fund’s shares.