FLC Flaherty and Crumrine Total Return Fund Inc

Annual Report
November 30, 2021

Flaherty & Crumrine Total Return Fund

To the Shareholders of Flaherty & Crumrine Total Return Fund (“FLC”):

Fiscal 2021 was another good year for preferred and income securities, as modest spread-tightening enhanced coupon return. Total return¹ on net asset value (“NAV”) was -1.6% for the fourth fiscal quarter² and 8.1% for the full fiscal year. Total return on market price of Fund shares over the same periods was -3.6% and 4.7%, respectively.

(1)Since inception on August 29, 2003.

(2)The Bloomberg 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.

Markets entered 2021 with cautious optimism, as COVID infections were near record levels while progress on vaccines was clearly positive. Uncertainty on one hand, and optimism on the other initially kept markets in a state of flux. A contentious Presidential transition and unprecedented Capitol riots kept news headlines buzzing and sentiment depressed as the year began. COVID remained a roller-coaster throughout the year, but markets shifted focus to more-positive factors such as accommodative policy, strong corporate earnings, healthy consumer balance sheets, and continued low interest rates.

The Federal Reserve (Fed) was a positive and powerful force supporting nearly all asset markets. Monetary policy was highly accommodative, with continued asset purchases by the Fed and low rates designed to raise inflation. The Fed’s goal of higher inflation was realized in the second half of 2021, with readings well above a 2% target. Investors are left to wonder how policymakers will navigate a new, higher-inflation landscape. Market levels at the end of 2021 imply investors remain confident that inflation is at least somewhat transitory, but the Fed has already indicated tighter policy is probably forthcoming in 2022.

Low interest rates and tighter credit spreads defined most of 2021. Non-call periods ended for a wide swath of the broader preferred market, resulting in advantageous refinancing opportunities for issuers. Many securities were refinanced with new issues paying lower coupons, but part of the market was redeemed without replacement. Redemptions resulted in a large reinvestment exercise across the preferred market, adding demand to an already technically strong market. Having more call protection in the portfolio than the broader market (especially compared to passive ETF products) and prioritizing it in

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

² September 1, 2021 – November 30, 2021

our management process resulted in only a moderate level of reinvestment within the portfolio, which helped sustain the Fund’s distributable income. However, persistently low long-term interest rates could outlast call protection and put pressure on income – and at least modestly higher leverage costs seem inevitable in 2022.

Broadly speaking, the Fund’s portfolio didn’t change much during the fiscal year, as current holdings continue to be preferable to most new-issue alternatives – especially in terms of current income. Banks remain our favorite credits, as reflected by our high allocation to the sector. Bank balance sheets strengthened through the pandemic, and the credit outlook is very positive. Spreads tightened in the sector, causing certain new-issue coupons to be lower than we might hope – but that properly reflects banks’ strong credit profile. Insurance has also done well, although insurers’ earnings continue to be a step behind banks due to lower investment yields and higher catastrophe losses in recent years.

Forecasting is always fraught with challenges, and 2022 is proving a difficult year to forecast. Investors have become accustomed to accommodative monetary policy and low inflation for many years – and it appears that those conditions may be changing. Many investors have never known higher interest rates or inflation much over 2% and have been conditioned to “buy the dip” when markets weaken. This mentality won’t unwind overnight, but it does create interesting dynamics and the potential for greater volatility as conditions begin to change. At the same time, it is important to remember that factors supporting credit markets thus far should remain healthy. These include good issuer credit quality, rising corporate earnings, a resilient consumer-driven economy with modest leverage, and interest rates that, while probably higher in 2022, are still well below historical averages. We will also point out that preferred and contingent capital (CoCo) securities have transformed over the years from long-duration instruments to intermediate-duration when first issued, with lower-duration seasoned issues further reducing interest-rate sensitivity at a portfolio level. Modestly higher interest rates may dampen near-term price returns, but they also could bring higher reinvestment yields to the Fund’s portfolio.

Preferreds and CoCos continue to compare favorably to most other fixed-income alternatives, especially on a risk-adjusted basis. Cash continues to flow into fixed income as the global search for yield continues, and fear of missing out (not being invested) has remained a top concern for investors. We expect some bumps along the road in 2022 as investors adjust to a changing economy and policy mix, but we believe the Fund is well positioned to meet its objectives.

The Fund has been through numerous interest rate cycles in the past, and its focus remains on generating attractive, long-term income for shareholders. Please read the discussion topics that follow for a broader discussion of dividend policy, our economic and credit outlook, and other matters of interest to shareholders.

Finally, we ask that shareholders elect their delivery preferences for shareholder reports. Instructions on how to make an election are in the discussion topics. Electronic delivery is recommended and helps lower Fund expenses, but printed reports remain available.

Sincerely,

The Flaherty & Crumrine Portfolio Management Team

December 31, 2021

For the six-month and one-year periods ended November 30, 2021, the Fund’s Benchmark Index¹ returned 0.4% and 3.7%, respectively. This index reflects 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).

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. The table and chart below depict total return on net asset value and total return on market price over the preceding 10 fiscal years.

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 and taxable income when you receive distributions.

¹The Fund’s Benchmark Index is the ICE BofA 8% Constrained Core West Preferred & Jr Subordinated Securities Index (P8JC), which 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%. For periods prior to 4/1/12, the benchmark was 50% of the monthly return on the ICE BofA Hybrid Preferred Securities 8% Constrained Index (P8HO) and 50% of the monthly return on the ICE BofA US Capital Securities US Issuers 8% Constrained Index (C8CT). P8HO includes taxable, fixed-rate, U.S. dollar denominated investment-grade, preferred securities listed on a U.S. exchange. C8CT includes investment grade fixed rate or fixed-to-floating rate $1,000 par securities that receive some degree of equity credit from the rating agencies or their regulators. All index returns include interest and dividend income, and, unlike the Fund’s returns, are unmanaged and do not reflect any expenses.

​The 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 $22.79 on December 31^st and assuming its January 2022 monthly distribution of $0.128 does not change, the annualized yield on market price of Fund shares is 6.7%. Of course, there can be no guarantee that the Fund’s dividend will not change based on market conditions.

U.S. Economic & Credit Outlook

The U.S. economy in 2021 continued a rapid recovery from 2020’s pandemic-induced recession, although higher inflation significantly reduced the economy’s gains in real (i.e., inflation-adjusted) terms. Using forecasts from the Federal Reserve Bank of Philadelphia’s Livingston Survey from December 17, 2021, real gross domestic product for 2021 would average 5.1% quarterly growth. However, nominal GDP growth would be much higher at 10.5% on the same basis. A rapid acceleration in inflation from less than 2% before the pandemic to over 5% in 2021 turned surging nominal growth into more moderate real growth. Mostly sidelined since the early 1990s, inflation is again a key risk in the economic and market outlooks.

As effective vaccines were deployed and COVID risks diminished in 2021, the U.S. economic recovery was led by strong growth in personal consumption expenditures (PCE). Spending initially focused on goods, with services expenditures rising in the second half of the year. PCE was supported by government transfer payments early in the year and by wage and salary income as employment recovered and wages rose. Although employment remains about 3.5 million jobs below its February 2020 peak, both income and spending are well above pre-pandemic levels. Moreover, consumers accumulated substantial savings over the past two years, which should keep spending strong even as the labor market tightens and employment growth slows in 2022.

Other sectors had mixed results. Business investment rose rapidly in the first half of 2021 but slowed in the second half as inflation jumped. It should grow moderately in 2022 as businesses look to improve productivity, although capital goods remain subject to supply chain disruptions that could limit investment. Nominal residential investment grew rapidly, but construction costs soared, leaving real residential investment down. Strong demand for housing should prompt rising real investment when inflation in the sector eventually cools. Finally, real government consumption rose modestly overall. Federal government spending was up early in the year but down thereafter. In contrast, state and local government spending was slow in 2021’s first half and picked up thereafter. Higher tax revenue from a strengthening economy should support modest growth in government spending in 2022.

Monetary policy offered strong support to the recovery while contributing to higher inflation. The Federal Reserve left its target range for short-term interest rates unchanged at 0-0.25% in 2021and grew its balance sheet by $120 billion per month for most of the year. In November 2021, the Fed began to taper securities purchases in its System Open Market Account (SOMA) by $15 billion per month. Reductions will accelerate to $30 billion per month in January, with all purchases expected to end in March 2022. However, fewer securities purchases mean less easy, not tighter, monetary policy. Rate hikes tighten policy, and the Federal Open Market Committee (FOMC) updated its “dot plot” to show most members expect three 25-bp hikes in 2022, which markets project will begin mid-year. Although that is more tightening than previously expected, it would still leave the federal funds rate under 1% at year-end and well below inflation. If inflation slows in the second half of 2022, as we expect, the FOMC probably will follow that deliberate pace of tightening. More aggressive rate hikes and outright sales of SOMA securities in 2023 are a risk if inflation does not fall as quickly as the FOMC expects.

A rapid resurgence in consumer and business demand (especially in personal spending and housing), easy monetary policy, a tighter labor market, and widespread supply chain disruptions caused inflation to rise faster and higher than nearly all economists’ expectations. The PCE deflator was up 5.7% overall and 4.7% excluding food and energy over 12 months ending in November 2021. The consumer price index (CPI) was even higher, up 6.8% overall and 4.9% excluding food and energy over the same period. While these inflation indices are likely to peak over the next several months, inflation has broadened beyond “rebound” items such as gasoline, hotel rooms and airline tickets, whose prices fell sharply early in the pandemic. Prices for housing, automobiles, commodities, and many services accelerated quickly. Wages also accelerated as employers scrambled to hire workers, building a foundation for future inflation. Remember that higher inflation was an objective of the Fed’s easy monetary policy, and there was always risk that inflation might become stickier than desired. We’ll find out how sticky in 2022.

Ten- and 30-year Treasury yields rose by 0.6% and 0.25% to 1.5% and 1.9%, respectively, over 12 months ending December 31, 2021. A growing economy, inflation that is currently well above Treasury yields, and Fed rate hikes should push intermediate and long-term interest rates up again in 2022. Yields already incorporate some of what is ahead, however, and we expect rates to rise moderately over several years, although they could be volatile.

Credit conditions improved along with the economy in 2021, and the credit outlook remains bright. Business bankruptcy filings are very low. Debt-to-GDP ratios fell at households, businesses and even the federal government. Corporate profits rebounded strongly, hitting a record high (after tax) as a share of GDP in the third quarter. Bank loan charge-offs and delinquencies are at or near historic lows. In addition to banking, industries that are major issuers of preferred and contingent capital securities remain broadly healthy. Higher interest rates have brightened outlooks for insurance and other financial services, while energy, utilities, and communications businesses should benefit from continued economic growth. Although some businesses will face challenges in 2022, credit fundamentals should remain quite strong overall.

Uncertain inflation and higher interest rates, rather than credit quality, are likely to be the main headwinds facing fixed income investors in 2022. We believe this favors sectors with higher credit spreads and moderate interest rate risk. Preferred and contingent capital securities offer both, and we continue to expect them to deliver attractive risk-adjusted returns ahead.

Implications of Fed Tightening on Dividends and Investments

As discussed in our topic “U.S. Economic & Credit Outlook”, the Federal Open Market Committee updated its “dot plot” to show most members expect three 25-bp hikes in 2022, which markets project will begin mid-year. More aggressive rate hikes and outright sales of System Open Market Account securities in 2023 are a risk if inflation does not fall as quickly as the FOMC expects. This schedule of tightening would still leave the federal funds rate at year-end under 1% and well below inflation, but it is a change in policy with implications for the fund.

What will higher short-term rates mean for the Fund? Most directly, cost of the Fund’s floating-rate leverage will increase, while income on most of the Fund’s investments are expected to hold about steady. Thus, higher leverage cost will reduce distributable income over the short run. That does not necessarily mean that the Fund’s dividend will fall immediately. However, higher leverage cost reduces income and will eventually lead to reduced Fund dividends unless it is offset by higher portfolio income. Higher rates could boost portfolio income over time as proceeds from called securities and the Fund’s ATM program are reinvested and some securities switch from fixed- to floating-rate, but it may take time to adjust. Distributable income is likely to fall over the next couple of years if short-term rates rise as expected.

More positively, higher short-term rates should be associated with a strong economy, which, in turn, should benefit credit performance and could lead to narrower yield spreads. This should be particularly true for financial institutions. Nearly all banks are “asset sensitive,” meaning their assets re-price more quickly than their liabilities. Banks’ net interest margins should expand as rates increase, improving profitability and allowing banks to build capital and

reserves more quickly. Yield spreads on preferred securities have room to contract, which could partly offset higher benchmark interest rates.

Near-zero short-term interest rates have held down leverage costs since early in the pandemic, but we know changes in rates are a normal part of the way credit markets function. The Fund’s objective is to produce current income, and we believe preferred securities still offer an attractive combination of high yield, good credit quality and tax-advantaged income that will serve investors through interest-rate cycles. Keep reading below for further discussion on the fund’s use of leverage.

Use of Leverage and Monthly Distributions to Fund Shareholders

When it comes to projecting income available to shareholders in future years, the elephant in the room is the expected cost of leverage. Use of leverage is an important part of the Fund’s strategy for generating high current income, and we could not produce the Fund’s current level of income without it. Leverage costs, which for the Fund are currently 1-month LIBOR + 0.80%, reset monthly, remained low throughout 2020 and 2021. We are, however, further into economic recovery in the United States and the Fed is poised to raise the federal funds rate in 2022.

Looking into 2022 and beyond, with potentially higher leverage costs, there are two questions that shareholders might ask.

If you expect the cost of leverage to increase, why not remove (or at least reduce) leverage from the Fund?

The answer is twofold. First, so long as the cost of leverage is below income earned on the portfolio – which has almost always been the case – income available to shareholders will be higher with leverage than it would be without leverage. Second, following the same logic, removing, or substantially reducing, leverage today would result in a material reduction in the current dividend rate, given current wide spreads between yields on preferred securities and cost of leverage. So even if leverage costs increase, benefits to distributable income over time can still be substantial as long as leverage costs do not exceed portfolio yield.

If you think short-term rates are going to increase, why don’t you hedge the cost of leverage?

In general, hedging is done for two reasons: first, to reduce absolute exposure to a particular risk; and second, to reduce volatility associated with a particular risk. When considering a hedge against a rise in short-term rates, one must weigh cost versus benefit. If we knew exactly when rates would rise and by how much, then we could evaluate the explicit costs and determine if it would be a winning trade.

Since we don’t know the exact timing or magnitude of higher short-term interest rates, a hedge is really another investment decision – one in which we would be betting that the cost of a hedge now (in the form of higher leverage costs today) will be lower than the actual cost of leverage (unhedged) over the hedge’s timeframe. In other words, the Fund’s distributable income would be lower today if we were to hedge the cost of leverage very far into the future. This is because today’s upward-sloping yield curve means the market already expects rates in the future to be higher, so that expected cost is reflected in hedging cost today.

We acknowledge this is complicated, but to simplify: hedging the cost of leverage today would result in lower income today – and may or may not result in improved return (relative to no hedge) in the future. This is because hedging today costs money.

We are not opposed to hedging leverage costs in the right context. However, we acknowledge that a hedge is a bet on the timing and magnitude of rate increases relative to the market’s pricing of these risks. Funds that hedged over the past dozen years missed out on quite a bit of distributable income, since short-term interest rates remained below hedged rates during most of the period. There are times when the market’s expectations of future rates make this a worthwhile bet, or when risk reduction offered by hedging is particularly valuable, but we don’t feel this is true today.

We would like our shareholders to understand that we are not currently hedging the cost of leverage and are unlikely to do so unless the market’s expectations (and, therefore, hedging costs) change. As a result, shareholders are receiving more income today (and have received more over the last several years) in exchange for potentially lower income and returns in the future. Given the current cost of hedging, we have so far decided it is best to take short-term rates as they come.

Electing Delivery Preferences

The Fund will not mail printed shareholder reports unless a shareholder specifically requests a paper copy. Shareholders now 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 have already elected edelivery, 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 or notices is expensive, and shareholders bear those expenses. Nonetheless, if you want a printed report, you may request it at no additional cost to you.

We would like to minimize mailed notices. Postal mailing of notices containing only a website link — while required in the absence of an edelivery election — is not cost effective for the Fund, which is why an edelivery election is the recommended option.

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 under any 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 2021 Calendar Year Distributions

In calendar year 2021, approximately 82.0% 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 18.1% 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 35.4% 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 2022’s distributions may not be the same (or even similar) to 2021.