UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-21869
HIGHLAND CREDIT STRATEGIES FUND
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(Exact name of registrant as specified in charter)
Two Galleria Tower
13455 Noel Road, Suite 800
DALLAS, TEXAS 75240
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(Address of principal executive offices) (Zip code)
James D. Dondero, President
Highland Credit Strategies Fund
Two Galleria Tower
13455 Noel Road, Suite 800
DALLAS, TEXAS 75240
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(Name and address of agent for service)
registrant's telephone number, including area code: (877) 665-1287
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Date of fiscal year end: DECEMBER 31
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Date of reporting period: DECEMBER 31, 2006
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Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
HIGHLAND FUNDS
[GRAPHIC OMITTED]
SHIELD ART
MANAGED BY HIGHLND CAPITAL MANAGEMENT, L.P.
HIGHLAND CREDIT STRATEGIES FUND
ANNUAL REPORT
DECEMBER 31, 2006
[GRAPHIC OMITTED] HIGHLAND CREDIT STRATEGIES FUND [GRAPHIC OMITTED]
SHIELD ART SHIELD ART
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TABLE OF CONTENTS
Portfolio Manager's Letter ............................................. 1
Fund Profile ........................................................... 2
Financial Statements ................................................... 3
Investment Portfolio ................................................ 4
Statement of Assets and Liabilities ................................. 12
Statement of Operations ............................................. 13
Statement of Changes in Net Assets .................................. 14
Statement of Cash Flows ............................................. 15
Financial Highlights ................................................ 16
Notes to Financial Statements ....................................... 17
Report of Independent Registered Public Accounting Firm ................ 22
Additional Information ................................................. 23
Important Information About This Report ................................ 27
Economic and market conditions change frequently. There is no assurance that the
trends described in this report will continue or commence.
PORTFOLIO MANAGERS' LETTER
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HIGHLAND CREDIT STRATEGIES FUND
Dear Shareholders:
We are pleased to provide you with our first annual shareholder report for
Highland Credit Strategies Fund (the "Fund"), for the period ended December 31,
2006. The Fund commenced investment operations on June 29, 2006. On December 29,
2006 (the last day the New York Stock Exchange was open for trading prior to the
end of the calendar year), the net asset value of the Fund was $20.08 per share,
as compared to $19.06 on June 29, 2006. On December 29, 2006, the closing market
price of the Fund's shares on the New York Stock Exchange was $21.16 per share,
as compared to $20.18 on June 29, 2006. During the period ended December 31,
2006, the Fund distributed to common shareholders $0.60 per share.
THE FUND'S INVESTMENTS:
The total return on the Fund's per share market price, assuming reinvestment of
dividends, for the period ended December 31, 2006 was 9.06%. The total return on
the Fund's net assets was 8.60% for the period ended December 31, 2006. The
variation in total returns is attributable to the increase in the market price
of the Fund's shares of 5.80% relative to an increase in the net asset value of
the Fund's shares of 5.35% during the period.
DIVIDEND DECLARATION:
On February 13, 2007, the Board of Directors declared a dividend of $0.15 per
common share, payable on the last day of business for the month of February
2007.
Respectfully submitted,
/S/ JAMES DONDERO /S/ MARK OKADA /S/ KURT PLUMER
JAMES DONDERO MARK OKADA KURT PLUMER
President Executive Vice President Portfolio Manager
Annual Report | 1
FUND PROFILE
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HIGHLAND CREDIT STRATEGIES FUND
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Objective
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Highland Credit Strategies Fund (the "Fund") seeks to provide both current
income and capital appreciation.
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Total Net Assets of Common Shares as of December 31, 2006
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$693.0 million
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Portfolio Data as of December 31, 2006
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The information below provides a snapshot of the Fund at the end of the
reporting period. The Fund is actively managed and the composition of its
portfolio will change over time.
QUALITY BREAKDOWN AS OF 12/31/06 (%)*
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Ba 11.4
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B 45.2
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Caa 17.5
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Ca 1.8
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NR 24.1
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TOP 5 SECTORS AS OF 12/31/06 (%)*
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Retail 10.6
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Healthcare -- Acute Care 9.8
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Transportation -- Auto 6.7
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Information Technology 6.6
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Utilities 6.4
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TOP 10 HOLDINGS AS OF 12/31/06 (%)*
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Movie Gallery, Inc. 2.7
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Ford Motor Co. 2.2
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Delphi Corp. 2.0
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Paramount Resources Ltd. (Canada) 2.0
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HCA, Inc. (Senior Loan Notes) 1.9
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Alliance Imaging, Inc. 1.8
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SunCom Wireless Holdings, Inc. 1.8
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HCA, Inc. (Corporate Notes and Bonds) 1.7
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Burlington Coat Factory Warehouse Corp. 1.7
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Metro-Goldwyn-Mayer Holdings II, Inc./LOC Acquisition Co. 1.5
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* Quality is calculated as a percentage of total notes and bonds. Sectors and
holdings are calculated as a percentage of net assets applicable to common
shareholders.
2 | Annual Report
FINANCIAL STATEMENTS
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DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
A GUIDE TO UNDERSTANDING THE FUND'S FINANCIAL STATEMENTS
INVESTMENT PORTFOLIO
The Investment Portfolio details all of the Fund's holdings and their market
value as of the last day of the reporting period. Portfolio holdings are
organized by type of asset and industry to demonstrate areas of concentration
and diversification.
STATEMENT OF ASSETS AND LIABILITIES
This statement details the Fund's assets, liabilities, net assets and common
share price as of the last day of the reporting period. Net assets are
calculated by subtracting all the Fund's liabilities (including any unpaid
expenses) from the total of the Fund's investment and non-investment assets. The
net asset value per common share is calculated by dividing net assets by the
number of common shares outstanding as of the last day of the reporting period.
STATEMENT OF OPERATIONS
This statement reports income earned by the Fund and the expenses accrued by the
Fund during the reporting period. The Statement of Operations also shows any net
gain or loss the Fund realized on the sales of its holdings during the period as
well as any unrealized gains or losses recognized over the period. The total of
these results represents the Fund's net increase or decrease in net assets from
operations applicable to common shareholders.
STATEMENT OF CHANGES IN NET ASSETS
This statement details how the Fund's net assets were affected by its operating
results, distributions to common shareholders and shareholder transactions from
common shares (e.g., subscriptions, redemptions and dividend reinvestments)
during the reporting period. The Statement of Changes in Net Assets also details
changes in the number of common shares outstanding.
STATEMENT OF CASH FLOWS
This statement reports net cash and foreign currency provided or used by
operating, investing and financing activities and the net effect of those flows
on cash and foreign currency during the period.
FINANCIAL HIGHLIGHTS
The Financial Highlights demonstrate how the Fund's net asset value per common
share was affected by the Fund's operating results. The Financial Highlights
also disclose the performance and certain key ratios (e.g., net expenses and net
investment income as a percentage of average net assets).
NOTES TO FINANCIAL STATEMENTS
These notes disclose the organizational background of the Fund, its significant
accounting policies (including those surrounding security valuation, income
recognition and distributions to shareholders), federal tax information, fees
and compensation paid to affiliates and significant risks and contingencies.
Annual Report | 3
INVESTMENT PORTFOLIO
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DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
PRINCIPAL AMOUNT ($) VALUE ($)
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SENIOR LOAN NOTES (A) - 96.6%
AEROSPACE - AEROSPACE/DEFENSE - 0.9%
2,441,463 AWAS Capital, Inc.
Second Priority Term Loan,
11.36%, 03/15/13 ................................. 2,478,084
TDS Investor Corp. (Travelport)
3,634,004 Dollar Term Loan, 8.37%, 08/23/13 ................ 3,647,814
356,888 Synthetic Letter of Credit,
8.37%, 08/23/13 .................................. 358,522
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6,484,420
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AEROSPACE - AIRLINES - 3.2%
Delta Airlines, Inc.
3,750,000 12/12/07 (b) ..................................... 2,428,125
10,000,000 Term Loan Equipment Notes,
8.00%, 09/29/12 .................................. 10,012,500
7,000,000 Northwest Airlines, Inc.
Term Loan DIP, 7.85%, 08/21/08 ................... 7,049,840
3,000,000 U S Airways, Inc.
Term Loan, 8.87%, 03/31/11 ....................... 3,025,320
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22,515,785
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AUTOMOBILE - 2.2%
15,000,000 Ford Motor Co.Term Loan,
8.36%, 12/15/13 .................................. 15,048,000
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BROADCASTING - 1.9%
9,135,579 Millennium Digital Media Systems,
LLC Term Facility,
8.99%, 06/30/11 .................................. 9,135,579
2,000,000 Persona Communications
Corp. (Canada)
Second Lien Term Loan,
11.37%, 04/12/14 ................................. 2,010,000
2,000,000 Revolution Studios
Tranche B Term Loan,
12/21/14 (b) ..................................... 1,990,000
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13,135,579
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CABLE - INTERNATIONAL CABLE - 0.1%
845,000 San Juan Cable, LLC
(Puerto Rico)
Second Lien Term Loan,
10.87%, 10/31/13 ................................. 855,563
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CABLE - US CABLE - 3.0%
6,000,000 Century Cable Holdings LLC
Revolver, 9.25%, 03/31/09 ........................ 5,805,000
9,000,000 Cequel Communications, LLC
NC Term Facility,
10.36%, 10/30/07 ................................. 9,011,250
WideOpenWest Finance LLC
2,400,000 First Lien Term Loan,
7.73%, 05/01/13 .................................. 2,407,008
3,250,000 Second Lien Term Loan,
10.37%, 05/01/14 ................................. 3,289,098
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20,512,356
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PRINCIPAL AMOUNT ($) VALUE ($)
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CHEMICALS - COMMODITY & FERTILIZER - 0.2%
1,388,889 Ferro Corp.Term Loan,
8.57%, 06/06/12 (c) .............................. 1,387,153
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CHEMICALS - SPECIALTY CHEMICALS - 0.8%
5,729,500 Solutia Inc.
New Term Loan B DIP,
8.96%, 03/31/07 .................................. 5,765,309
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CONSUMER DURABLES - 0.4%
2,862,201 Rexair LLC
First Lien Term Loan,
9.62%, 06/30/10 .................................. 2,869,357
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CONSUMER NON-DURABLES - 2.0%
1,512,000 Camelbak Products LLC
First Lien Term Loan,
9.45%, 08/04/11 .................................. 1,477,980
2,000,000 DS Waters Enterprises, Inc.
Term Loan B, 7.82%, 10/27/12 ..................... 1,978,760
1,000,000 GTM Holding, Inc. (GoldToe)
First Lien Term Loan,
8.13%, 10/30/13 .................................. 1,007,190
5,077,650 Spectrum BrandsU. S. Dollar
Term Loan B,
8.62%, 02/07/12 .................................. 5,106,745
3,990,000 VNU Inc./Nielsen Finance LLC
Dollar Term Loan,
8.19%, 08/09/13 .................................. 4,024,314
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13,594,989
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DIVERSIFIED MEDIA - 3.3%
3,000,000 Endurance Business Media, Inc.
Second Lien Term Loan,
12.60%, 01/24/14 ................................. 3,022,500
Metro-Goldwyn-Mayer Holdings II,
Inc./LOC Acquisition Co.
2,853,659 Tranche A Term Loan,
8.61%, 04/08/11 .................................. 2,823,638
10,441,169 Tranche B Term Loan,
8.61%, 04/08/12 .................................. 10,346,572
3,500,000 North American Membership
Group, Inc. Revolver,
05/19/10 (b) ..................................... 3,436,300
500,000 Panavision, Inc.
Second Lien Term Loan,
12.38%, 03/30/12 ................................. 508,440
3,000,000 PBI Media, Inc.
Second Lien Term Loan,
11.38%, 09/30/13 ................................. 3,015,000
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23,152,450
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ENERGY - EXPLORATION & PRODUCTION - 3.7%
ATP Oil & Gas Corp.
3,970,050 First Additional Term Loan,
8.92%, 04/14/10 .................................. 4,007,289
7,980,000 First Lien Term Loan,
8.95%, 04/14/10 .................................. 8,054,852
14,000,000 Paramount Resources Ltd. (Canada)
Term Loan, 9.86%, 08/28/12 ....................... 13,842,500
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25,904,641
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4 | See accompanying Notes toFinancial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
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DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
PRINCIPAL AMOUNT ($) VALUE ($)
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SENIOR LOAN NOTES (CONTINUED)
ENERGY - OTHER ENERGY - 1.7%
Alon USA Energy, Inc.
221,667 Edington Facility,
7.63%, 06/22/13 .................................. 222,637
1,768,889 Paramount Facility,
7.66%, 06/22/13 .................................. 1,776,637
3,000,000 Endeavour International
Holding B.V. (Netherlands)
Second Lien Term Loan,
12.37%, 11/01/11 ................................. 3,075,000
4,000,000 MEG Energy Corp. (Canada)
Interim Loan, 10.12%, 09/29/13 ................... 3,952,480
3,000,000 Willbros USA, Inc.
Syndicate Term Loan,
5.25%, 10/27/09 .................................. 3,000,000
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12,026,754
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ENERGY - REFINING - 0.3%
2,000,000 J Ray McDermott, SA (Panama)
Synthetic Facility,
5.27%, 06/06/12 .................................. 2,010,000
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FINANCIAL - 1.3%
750,000 Arrowhead General Insurance
Agency, Inc. Second Lien
Term Loan, 02/08/13 (b) .......................... 761,250
994,987 Checksmart Financial Co.
First Lien Tranche B
Term Loan, 8.06%, 05/01/12 ....................... 996,858
5,000,000 Concord Re Ltd. (Bermuda)
Term Loan, 9.57%, 02/29/12 ....................... 5,075,000
997,500 First American Payment
Systems, L.P. Term Loan,
8.63%, 10/06/13 .................................. 1,002,487
995,000 Transfirst Holdings, Inc.
First Lien Term Loan,
7.87%, 08/15/12 .................................. 1,001,219
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8,836,814
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FOOD AND DRUG - 1.7%
2,092,645 Duloxetine Royalty Sub
(Cayman Island)
Term Loan, 10/18/13 (b) .......................... 2,108,340
7,855,816 Jean Coutu Group, Inc.
Term Loan B, 7.94%, 07/30/11 ..................... 7,878,441
1,984,962 Roundy's Supermarkets, Inc.
Term Loan, 8.40%, 11/03/11 ....................... 2,005,308
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11,992,089
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FOOD/TOBACCO - BEVERAGES & BOTTLING - 0.3%
1,995,000 PBM Holdings, Inc.
Term Loan, 8.10%, 09/29/12 ....................... 2,009,963
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FOOD/TOBACCO - FOOD/TOBACCO PRODUCERS - 1.3%
8,902,101 Merisant Co.Tranche B
Term Loan, 8.63%, 01/11/10 ....................... 8,913,229
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PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
FOOD/TOBACCO - RESTAURANTS - 0.8%
3,328,797 Garden Fresh Restaurant Corp.
First Lien Term Loan B,
8.62%, 06/22/11 .................................. 3,341,281
1,995,000 Restaurant Co., The
Term Loan, 8.12%, 05/03/13 ....................... 2,011,199
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5,352,480
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GAMING/LEISURE - GAMING - 0.8%
5,690,614 Drake Hotel Acquisition
B Note 1, 8.25%, 04/01/07 (c) .................... 5,690,614
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GAMING/LEISURE - OTHER LEISURE - 1.9%
3,980,000 Cedar Fair L.P. (Canada)
US Term Loan, 7.87%, 08/30/12 .................... 4,024,775
1,979,898 Kerasotes Showplace Theatres LLC
Term B1 Loan, 7.94%, 10/28/11 .................... 1,987,739
5,984,887 Kuilima Resort Co.
First Lien Term Loan,
8.07%, 09/30/10 .................................. 5,917,556
987,635 Pivotal Group Promontory
First Lien Term Loan,
8.07%, 08/31/10 .................................. 970,845
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12,900,915
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HEALTHCARE - ACUTE CARE - 7.4%
12,526,875 Alliance Imaging, Inc.
Tranche C Term Loan,
7.92%, 12/29/11 .................................. 12,599,280
1,466,250 ComPsych Investments Corp.
Term Loan, 8.12%, 04/11/12 ....................... 1,473,581
3,015,000 Cornerstone Healthcare
Group Holding, Inc. Senior
Subordinated Unsecured Notes,
14.00%, 07/15/12 (d) ............................. 2,185,875
HCA, Inc.
10,000,000 Second Lien Bridge Loan,
09/15/07 (b) ..................................... 10,000,000
13,000,000 Tranche B Term Loan,
7.86%, 11/17/13 .................................. 13,155,870
2,434,028 MultiPlan, Inc.Term C Loan,
7.85%, 04/12/13 .................................. 2,434,807
National Mentor Holdings, Inc.
230,000 Institutional Line of Credit
Facility, 5.84%, 06/29/13 ........................ 230,862
3,751,150 Tranche B Term Loan,
7.87%, 06/29/13 .................................. 3,764,054
Sheridan Healthcare, Inc.
293,040 Delayed Draw Term Loan,
8.37%, 11/09/11 .................................. 294,872
1,701,960 First Lien Term C Loan,
8.37%, 11/09/11 .................................. 1,712,597
1,500,000 Second Lien Term Loan,
12.37%, 11/09/12 ................................. 1,525,320
2,000,000 Triumph Healthcare Second
Holdings LLC Second Lien
Term Loan, 13.48%, 07/28/14 ...................... 2,000,000
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51,377,118
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See accompanying Notes to Financial Statements. | 5
INVESTMENT PORTFOLIO (CONTINUED)
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DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
PRINCIPAL AMOUNT ($) VALUE ($)
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SENIOR LOAN NOTES (CONTINUED)
HEALTHCARE - ALTERNATE SITE SERVICES - 1.0%
6,000,000 InSight Health Services Corp.
Tranche B Term Loan,
7.61%, 04/06/14 .................................. 6,043,140
995,274 Renal Advantage Inc.
Tranche B Term Loan,
7.89%, 10/06/12 .................................. 1,003,355
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7,046,495
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HEALTHCARE - MEDICAL PRODUCTS - 4.6%
9,952,259 CCS Medical, Inc. (Chronic Care)
First Lien Term Loan,
8.62%, 09/30/12 .................................. 9,735,598
4,000,000 Golden Gate National
Senior Care LLC
Second Lien Term Loan,
13.12%, 09/14/11 ................................. 4,070,000
6,965,000 HealthSouth Corp.
Term Loan B, 8.62%, 03/10/13 ..................... 7,013,825
MMM Holding, Inc./NAMM
Holdings, Inc./PHMC
(Puerto Rico)
2,700,994 NAMM New Term Loan,
7.62%, 08/22/11 .................................. 2,694,241
352,689 NAMM New Term Loan,
7.62%, 08/22/11 .................................. 351,807
635,528 NAMM Original Term Loan,
7.62%, 08/22/11 .................................. 633,939
61,487 NAMM PHMC Acquistion
Term Loan, 7.62%, 08/22/11 ....................... 61,333
2,213,526 PHMC Acquisition
Term Loan, 7.62%, 08/10/11 ....................... 2,207,992
Warner Chilcott Co., Inc.
(Puerto Rico)
125,031 Dovobet Delayed Draw Term Loan,
7.87%, 01/18/12 (b) .............................. 125,446
1,287,985 Dovonex Delayed Draw Term Loan,
7.87%, 01/18/12 (b) .............................. 1,291,204
2,817,491 Tranche B Acquisition Date Term Loan,
7.92%, 01/18/12 (b) .............................. 2,832,086
432,286 Tranche C Acquisition Date
Term Loan, 01/18/12 (b) .......................... 434,716
579,978 Warner Chilcott Corp.
Tranche C Acquisition Date
Term Loan, 7.87%, 01/18/12 ....................... 583,237
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32,035,424
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HOUSING - BUILDING MATERIALS - 1.8%
2,404,588 Atrium Cos., Inc.
Closing Date Term Facility,
8.13%, 05/31/12 .................................. 2,348,994
5,961,208 Custom Building Products,
Inc.First Lien Term Loan,
7.61%, 10/20/11 .................................. 5,976,111
3,990,000 Roofing Supply Group LLC
First Lien Term Loan,
8.61%, 08/31/13 .................................. 3,960,075
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12,285,180
------------
PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
HOUSING- REAL ESTATE DEVELOPMENT - 5.5%
1,217,162 DESA LLC
Term Loan, 11.12%, 11/26/11 ...................... 1,150,218
Flag Luxury Properties
Holdings, LLC
1,496,241 First Lien Term Loan,
8.64%, 03/21/11 .................................. 1,473,797
1,496,118 First Lien Term Loan,
9.10%, 03/21/11 .................................. 1,502,671
Ginn LA Conduit Lender, Inc.
1,257,683 First Lien Tranche A Credit
Linked Deposit,
8.37%, 06/08/11 (b) .............................. 1,210,520
2,732,032 First Lien Tranche B Term Loan,
8.37%, 06/08/11 (b) .............................. 2,629,581
994,975 LBREP/L-Suncal Master I LLC
First Lien, 8.63%, 01/19/10 ...................... 975,075
10,000,000 LNR Property Corp.
Initial Tranche B Term Loan,
8.12%, 07/12/11 .................................. 10,043,800
2,500,000 November 2005 Land Investors, LLC
Second Lien Term Loan,
12.50%, 04/24/12 ................................. 2,475,000
7,500,000 Rubicon GSA II LLC (Australia)
Term Loan, 8.10%, 08/30/08 ....................... 7,500,000
Westgate Investments LLC
7,334,691 Senior Secured Loan,
13.00%, 07/15/10 (d) ............................. 7,334,691
1,504,033 Senior Unsecured Loan,
18.00%, 08/03/12 ................................. 1,507,793
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37,803,146
------------
INFORMATION TECHNOLOGY - 5.5%
2,000,000 Data Transmission Network Corp.
Second Lien Term Loan,
13.39%, 09/10/13 ................................. 2,010,000
5,000,000 Infor Enterprise Solutions
Holdings, Inc. (Luxemboug)
Stage One U.S. Bridge Facility,
11.50%, 07/29/13 ................................. 5,062,500
Infor Enterprise Solutions
Holdings, Inc. (Luxembourg)
2,736,000 Delayed Draw Term Loan,
9.12%, 07/28/12 .................................. 2,770,200
5,244,000 Initial US Term Facility,
9.08%, 07/28/12 .................................. 5,283,330
8,000,000 NameMedia, Inc.Term Loan,
11.33%, 08/31/08 ................................. 8,040,000
2,619,063 ON Semiconductor Corp.
Term Loan H, 7.62%, 12/15/11 ..................... 2,635,432
4,858,156 Open Solutions Inc.
First Lien Term Loan,
7.87%, 09/03/11 .................................. 4,864,229
997,500 Open Text Corp. (Canada)
Term Loan, 7.90%, 10/02/13 ....................... 1,003,734
2,500,000 Secure Computing Corp.
Term Loan, 8.58%, 08/31/13 ....................... 2,518,750
2,000,000 Serena Software, Inc.
Term Loan, 7.62%, 03/11/13 ....................... 2,004,160
2,000,000 Spansion LLC
Term Loan B, 8.38%, 11/01/12 ..................... 2,007,500
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38,199,835
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6 | See accompanying Notes toFinancial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
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DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
MANUFACTURING - 4.2%
7,000,000 Acument Global Technologies, Inc.
(TFS Acquisition Corp.)
Term Loan, 8.92%, 08/11/13 ....................... 7,052,500
2,992,500 CST Industries, Inc.Term Loan,
8.55%, 08/09/13 .................................. 2,987,712
947,826 FR X Ohmstede Acquisitions Co.
Term B Loan, 8.44%, 08/09/13 ..................... 960,262
4,975,000 Global Petroleum, Inc.
(SPI Petroleum)
Term Loan, 9.88%, 07/26/13 ....................... 4,999,875
Matinvest 2 SAS
(Deutsche Connector)
2,250,000 B-2 Facility, 7.90%, 06/22/14 .................... 2,271,105
2,250,000 C-2 Facility, 8.08%, 06/22/15 .................... 2,282,355
1,011,458 Matinvest 2 SAS
(Deutsche Connector) (France)
Mezz A USD Facility,
13.54%, 06/22/16 ................................. 1,039,273
Prysmian Power Cables & Systems, Inc.
1,525,200 B3b Term Loan,
7.88%, 08/25/13 .................................. 1,531,880
381,300 C5b Term Loan,
8.38%, 08/25/13 .................................. 383,923
Quantum Corp.
2,916,667 First Lien Term Loan,
9.44%, 08/22/12 .................................. 2,920,313
1,000,000 Second Lien Term Loan,
13.69%, 08/22/13 ................................. 1,002,500
2,000,000 Ray Acquisition SCA (Rexel)
(France) Term Loan B3-A US,
7.61%, 08/02/14 .................................. 2,012,500
------------
29,444,198
------------
METALS/MINERALS - OTHER METALS/MINERALS - 2.8%
1,326,316 Euramax International Holdings B.V.
Second Lien European Loan,
12.49%, 06/29/13 ................................. 1,299,789
Euramax International, Inc.
2,884,136 First Lien Domestic Term Loan,
8.06%, 06/29/12 .................................. 2,878,368
2,673,684 Second Lien Domestic Term Loan,
12.49%, 06/29/13 ................................. 2,596,816
5,633,333 James River Coal Co.
Credit Linked Certificate
of Deposit, 8.85%, 11/30/11 ...................... 5,633,333
1,600,000 Oglebay Norton Co.
Tranche B Term Loan,
7.87%, 07/31/12 .................................. 1,616,000
1,989,950 PinnOak Resources, LLC
Term Loan, 8.78%, 11/23/12 ....................... 1,960,101
1,736,875 United Central Industrial
Supply Co., L.L.C.Term Loan,
8.61%, 03/31/12 .................................. 1,747,731
1,488,750 Universal Buildings Products,
Inc.Term Loan,
8.74%, 04/28/12 .................................. 1,481,306
------------
19,213,444
------------
PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
RETAIL- 8.2%
3,467,443 Blockbuster Entertainment Corp.
Tranche B Term Loan,
8.97%, 08/20/11 .................................. 3,484,087
11,833,160 Burlington Coat Factory
Warehouse Corp. Term Loan,
7.53%, 05/28/13 .................................. 11,695,186
3,000,000 CSK Auto, Inc.
Term Loan, 8.38%, 06/30/12 ....................... 3,007,500
994,565 Eddie Bauer, Inc.
Term Loan, 9.57%, 06/21/11 ....................... 994,565
7,223,706 Home Interiors & Gifts, Inc.
Initial Term Loan,
10.43%, 03/31/11 ................................. 5,300,395
Movie Gallery, Inc.
1,336,494 Term Loan A, 10.37%, 04/27/11 .................... 1,316,928
18,707,710 Term Loan B, 04/27/11 (b) ........................ 18,413,624
4,443,038 Neiman Marcus Group, Inc. (The)
Term Loan, 7.60%, 04/06/13 ....................... 4,479,915
1,990,000 Sports Authority, Inc., The
Term Loan B, 7.61%, 05/03/13 ..................... 1,984,189
6,000,000 Toys "R" Us
Tranche B Term Loan,
9.63%, 07/19/12 .................................. 6,183,720
------------
56,860,109
------------
SERVICE - ENVIRONMENTAL SERVICES - 1.3%
953,191 Alliance Laundry Systems LLC
Term Loan, 7.63%, 01/27/12 ....................... 961,532
6,237,288 Safety-Kleen JPMP SK Holdings Ltd.
GBP Term Loan B1, 7.88%, 08/02/13 ................ 6,252,881
1,762,712 Safety-Kleen Systems, Inc.
Synthetic Letter of Credit,
7.88%, 08/02/13 .................................. 1,767,119
------------
8,981,532
------------
SERVICE - OTHER SERVICES - 3.9%
2,992,500 Education Management Corp.
Tranche B Term Loan,
7.88%, 06/01/13 .................................. 3,016,081
2,000,000 Koosharem Corp.
Second Lien Term Loan,
15.75%, 06/30/13 ................................. 1,975,000
La Petite Academy, Inc.
6,483,750 Closing Date First Lien Term Loan,
8.32%, 08/16/12 .................................. 6,491,855
4,000,000 Second Lien Term Loan,
12.57%, 02/16/13 ................................. 4,040,000
9,000,000 NES Rentals
Second Lien Term Loan,
12.13%, 07/20/13 ................................. 9,084,420
1,458,815 Survey Sampling International, LLC
Term Loan, 8.75%, 05/06/11 ....................... 1,459,719
747,500 Vanguard Car Rental USA Holding, Inc.
Term Loan,
8.36%, 06/14/13 .................................. 753,188
------------
26,820,263
------------
See accompanying Notes to Financial Statements. | 7
INVESTMENT PORTFOLIO (CONTINUED)
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
TELECOMMUNICATIONS - 3.7%
992,506 Gabriel Communications
Finance Co. Term Loan B,
10.41%, 05/12/12 ................................. 993,747
933,333 Madison River Capital
Term B-1, 7.62%, 07/29/12 ........................ 936,105
8,000,000 PaeTec Communications, Inc.
Second Lien Term Loan,
12.88%, 06/12/13 ................................. 8,167,520
Sorenson Communications, Inc.
2,000,000 Revolver, 08/16/12 (b) ........................... 1,994,840
5,000,000 Second Lien Term Loan,
12.39%, 02/16/14 ................................. 5,062,500
5,985,000 Tranche B Term Loan,
8.36%, 08/16/13 .................................. 6,018,636
1,250,000 Stratos Global Corp./Stratos
Funding LP (Canada)
Term B Facility, 8.10%, 02/13/12 ................. 1,252,350
1,000,000 Time Warner Telecom Holdings Inc.
Term Loan B, 7.60%, 01/07/13 ..................... 1,007,500
------------
25,433,198
------------
TRANSPORTATION - AUTO - 6.7%
Carey International, Inc.
3,949,495 First Lien Term Loan,
9.19%, 05/10/11 .................................. 3,910,000
2,596,191 Second Lien Term Loan,
17.28%, 05/10/12 ................................. 2,550,758
4,222,507 Conseco, Inc.Term Loan,
8.63%, 12/15/08 .................................. 4,243,619
380,167 Cooper-Standard Automotive
Canada Ltd. (Canada)
Tranche B Term Loan,
7.88%, 12/23/11 .................................. 380,882
Cooper-Standard Automotive Inc
994,975 Term Loan D, 7.88%, 12/23/11 ..................... 996,218
84,453 Tranche C Term Loan,
7.88%, 12/23/11 .................................. 84,585
3,000,000 Dana Corp.DIP Term Loan,
7.55%, 04/13/08 .................................. 3,002,160
2,000,000 Dayco Products LLC - (Mark IV)
Second Lien Term Loan,
11.28%, 12/31/11 ................................. 2,008,320
8,495,000 Delphi Corp.Term Loan,
13.75%, 06/14/11 ................................. 8,731,246
485,083 Environmental Systems Products
Holdings Inc.Term Loan,
8.93%, 12/12/08 .................................. 487,509
Key Plastics LLC
1,000,000 Term Loan B, 8.86%, 06/24/10 ..................... 1,008,750
3,459,900 Term Loan C, 11.60%, 06/29/11 .................... 3,494,499
Keystone Automotive
Operations, Inc.
89,661 Term Loan B, 7.91%, 10/30/09 ..................... 89,690
2,046,919 Term Loan C, 7.85%, 10/30/10 ..................... 2,047,574
4,985,000 Lear Corp.
First Lien Term Loan B,
7.96%, 04/25/12 .................................. 4,984,202
3,604,703 Motor Coach Industries
International, Inc.
Second Lien Term Loan,
14.12%, 12/01/08 ................................. 3,694,820
PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
TRANSPORTATION - AUTO (CONTINUED)
Navistar International Corp.
650,094 Delay Draw Term Loan,
10.32%, 02/22/09 ................................. 659,442
3,683,240 Delay Draw Term Loan,
10.37%, 02/22/09 ................................. 3,736,205
------------
46,110,479
------------
TRANSPORTATION - LAND - 1.2%
2,000,000 New Century Transportation, Inc.
Term Loan B, 8.63%, 08/14/12 ..................... 2,006,240
7,147,900 SIRVA Worldwide, Inc.
Tranche B Term Loan,
11.62%, 12/01/10 ................................. 6,641,543
------------
8,647,783
------------
UTILITIES - 6.4%
5,000,000 ANP Funding I, LLC
Tranche A Term Loan, 07/29/10 (b) ................ 5,035,000
Calpine Corp.
1,000,000 Second Lien Term Loan, 07/16/07 (e) .............. 1,139,250
1,000,000 Second Priority DIP Term Loan,
9.50%, 12/20/07 .................................. 1,015,620
Coleto Creek Power, LP
4,975,000 Second Lien Term Loan,
9.37%, 06/28/13 .................................. 4,701,375
382,166 Synthetic Facility,
5.27%, 06/28/13 .................................. 381,332
5,589,745 Term Loan, 8.12%, 06/28/13 ....................... 5,582,758
GBGH, LLC (U S Energy)
5,000,000 First Lien Term Loan,
10.94%, 08/07/13 ................................. 5,012,500
5,000,000 Second Lien Term Loan,
7.94%, 08/07/14 .................................. 5,012,500
Magnolia Energy LP
30,043 Additional PCLC Facility, 12/14/11 (b) ........... 24,535
465,044 Facility A, 12/14/11 (b) ......................... 378,234
4,504,913 Facility B, 12/14/11 (b) ......................... 3,679,028
1,000,000 NE Energy, Inc.
Second Lien Term Loan,
11.75%, 05/01/14 ................................. 1,017,080
Plum Point Energy Associates, LLC
607,134 First Lien Term Loan,
5.37%, 03/14/14 .................................. 611,687
2,093,334 Funded Letter of Credit,
8.62%, 03/14/14 .................................. 2,114,267
Reliant Energy, Inc.
571,429 New Term Loan, 7.73%, 12/01/10 ................... 575,537
428,571 Pre-Funded Letter of Credit,
5.22%, 12/01/10 .................................. 428,571
TECO Panda Generating Co.
- Gila River Power Station
598,071 Project Letter of Credit,
06/01/12 (b) ..................................... 892,621
1,319,117 Tranche A Term Loan,
06/01/12 (b) ..................................... 1,968,782
1,272,560 Tranche B Term Loan,
06/01/20 (b) ..................................... 1,967,695
38,585 Working Capital, 06/01/12 (b) .................... 57,588
8 | See accompanying Notes toFinancial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
SENIOR LOAN NOTES (CONTINUED)
UTILITIES (CONTINUED)
TECO Panda Generating Co.
- Union Power Partners, L.P.
173,633 Letter of Credit, 06/01/12 (b) (e) ............... 259,148
775,951 Tranche A Term Loan,
06/01/12 (b) (e) ................................. 1,158,107
744,913 Tranche B Term Loan,
06/01/20 (b) (e) ................................. 1,151,822
77,170 Working Capital, 06/01/12 (b) (e) ................ 115,177
------------
44,280,214
------------
WIRELESS - CELLULAR/PCS - 0.6%
1,990,000 Cricket Communications, Inc.
Term B Facility, 8.25%, 06/16/13 ................. 2,006,378
2,000,000 Insight Midwest Holdings, LLC
B Delayed Draw Term Loan,
7.61%, 04/06/14 .................................. 2,011,880
------------
4,018,258
------------
Total Senior Loan Notes
(Cost $665,087,602) ............................ 669,515,136
------------
FOREIGN DENOMINATED SENIOR LOAN NOTES - 7.7%
CANADA - 0.9%
CAD
Persona Communications Corp.
5,965,455 First Lien CDN Delayed-Draw
Term Loan, 10/12/13 (b) .......................... 5,164,729
1,232,727 First Lien CDN Tranche B
Term Loan, 7.43%, 10/12/13 ....................... 1,067,262
------------
6,231,991
------------
FRANCE - 2.7%
EUR
Ypso Holding SA
2,680,552 Eur B (Acq) 1 Facility,
5.87%, 06/15/14 .................................. 3,511,033
4,373,530 Eur B (Acq) 2 Facility,
5.87%, 06/15/14 .................................. 5,728,526
6,945,918 Eur B (Recap) 1 Facility,
5.87%, 06/15/14 .................................. 9,111,348
------------
18,350,907
------------
GERMANY - 1.3%
EUR
5,000,000 P7S1 Holding II S.a.r.L - GMP
Facility B, 7.09%, 07/08/11 ...................... 6,612,514
2,000,000 Iesy Hessen/ISH NRW
GMBH/Arena Sport
Euro Senior Secured Term Loan,
6.63%, 10/15/11 .................................. 2,643,898
------------
9,256,412
------------
ITALY - 0.6%
EUR
3,000,000 H3G S.p.A.Euro
Term Loan A1, 12/30/11 (b) ....................... 3,896,618
------------
PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
UNITED KINGDOM - 2.2%
GBP
420,286 Eggborough Power Ltd.Term Loan,
03/31/22 (b) (d) (e) ............................. 2,681,539
Mobileserv Ltd. (Phones 4U)
3,250,000 Facility B , 7.65%, 09/22/14 ..................... 6,380,547
3,250,000 Facility C, 8.15%, 09/22/15 ...................... 6,388,562
------------
15,450,648
------------
Total Foreign Denominated
Senior Loan Notes
(Cost $51,360,643) ............................. 53,186,576
------------
CORPORATE NOTES AND BONDS - 26.6%
AUTOMOTIVE - 0.5%
3,332,000 Ford Motor Credit Co.
8.11%, 01/13/12 (f) .............................. 3,305,794
------------
CABLE - US CABLE - 1.1%
4,500,000 CCH I LLC11.00%, 10/01/15 ......................... 4,640,625
2,000,000 Charter Communications Inc.
5.88%, 11/16/09 .................................. 2,855,000
------------
7,495,625
------------
CHEMICALS - SPECIALTY CHEMICALS - 1.9%
Solutia Inc.
8,000,000 10/15/27 (e) ..................................... 7,830,000
5,500,000 10/15/37 (e) ..................................... 5,383,125
------------
13,213,125
------------
CONSUMER NON-DURABLES - 1.1%
3,000,000 Ames True Temper
9.37%, 01/15/12 (f) .............................. 3,060,000
3,100,000 Remington Arms Co., Inc.
10.50%, 02/01/11 ................................. 2,952,750
1,875,000 Solo Cup Co.
8.50%, 02/15/14 .................................. 1,631,250
------------
7,644,000
------------
DIVERSIFIED MEDIA - 0.8%
4,500,000 Network Communications, Inc.
10.75%, 12/01/13 ................................. 4,567,500
1,000,000 PRIMEDIA, Inc.
10.75%, 05/15/10 (f) ............................. 1,045,000
------------
5,612,500
------------
ENERGY - EXPLORATION & PRODUCTION - 0.3%
1,750,000 Opti Canada, Inc.
8.25%, 12/15/14 (g) .............................. 1,806,875
------------
FINANCIAL - 0.3%
2,000,000 Penhall International, Corp.
12.00%, 08/01/14 (g) (h) ......................... 2,170,000
------------
FOOD AND DRUG - 0.1%
496,383 Cinacalcet Royalty
8.00%, 03/30/17 .................................. 565,876
------------
See accompanying Notes to Financial Statements. | 9
INVESTMENT PORTFOLIO (CONTINUED)
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
CORPORATE NOTES AND BONDS (CONTINUED)
FOOD/TOBACCO-FOOD/TOBACCO PRODUCERS - 2.2%
` Chiquita Brands International, Inc.
3,000,000 7.50%, 11/01/14 .................................. 2,760,000
5,000,000 8.88%, 12/01/15 .................................. 4,812,500
10,000,000 Swift & Co., PIK Holdco Notes,
8.00%, 03/19/10 .................................. 7,500,000
------------
15,072,500
------------
FOREST PRODUCTS - PAPER - 0.9%
4,000,000 Graphic Packaging
International, Inc.
9.50%, 08/15/13 (h) .............................. 4,240,000
1,500,000 Impress Metal Packaging Holdings
BV (Netherlands)
8.51%, 09/15/13 (f) (g) .......................... 1,511,250
500,000 Newpage Corp.
12.00%, 05/01/13 ................................. 531,250
------------
6,282,500
------------
GAMING/LEISURE - OTHER LEISURE - 1.9%
4,500,000 Six Flags, Inc.
8.88%, 02/01/10 .................................. 4,376,250
1,000,000 True Temper Sports, Inc.
8.38%, 09/15/11 .................................. 875,000
8,000,000 Trump Entertainment
Resorts Holdings LP
8.50%, 06/01/15 .................................. 8,000,000
------------
13,251,250
------------
HEALTHCARE - ACUTE CARE - 2.4%
HCA, Inc.
2,100,000 6.30%, 10/01/12 .................................. 1,926,750
3,000,000 8.36%, 04/15/24 .................................. 2,654,472
11,000,000 9.63%, 11/15/16 (g) .............................. 11,852,500
------------
16,433,722
------------
HEALTHCARE - MEDICAL PRODUCTS - 0.9%
250,000 Medquest, Inc., Series B
11.88%, 08/15/12 ................................. 207,500
6,125,000 Rotech Healthcare, Inc.
9.50%, 04/01/12 .................................. 6,033,125
------------
6,240,625
------------
HOUSING - BUILDING MATERIALS - 0.1%
1,000,000 Builders FirstSource, Inc.
9.62%, 02/15/12 (f) .............................. 988,750
------------
INFORMATION TECHNOLOGY - 1.0%
6,000,000 MagnaChip Semiconductor
8.61%, 12/15/11 (f) .............................. 5,190,000
2,000,000 NXP BV/NXP Funding LLC
(Netherlands)
8.12%, 10/15/13 (f) (g) .......................... 2,040,000
------------
7,230,000
------------
PRINCIPAL AMOUNT ($) VALUE ($)
-------------------- ---------
MANUFACTURING - 0.5%
1,000,000 Polypore, Inc.
8.75%, 05/15/12 .................................. 1,000,000
2,150,000 TFS Acquisition Corp
12.87%, 08/01/14 (f) (g) ......................... 2,203,750
------------
3,203,750
------------
METALS/MINERALS - 0.1%
350,000 Doe Run Resources Corp.
11.75%, 11/01/08 (i) ............................ 346,500
------------
RETAIL - 2.3%
9,500,000 Blockbuster Inc.
9.00%, 09/01/12 .................................. 9,238,750
2,000,000 Gregg Appliances, Inc.
9.00%, 02/01/13 .................................. 1,920,000
2,000,000 Linens `n Things, Inc.
11.00%, 01/15/14 (f) ............................. 1,950,000
4,000,000 Movie Gallery Inc.
11.00%, 05/01/12 ................................. 3,100,000
------------
16,208,750
------------
SERVICE - OTHER SERVICES - 1.1%
7,550,000 HydroChem Industrial Services, Inc.
9.25%, 02/15/13 (g) .............................. 7,625,500
------------
TRANSPORTATION - 3.8%
5,000,000 American Tire Distributors
Holdings, Inc.
11.62%, 04/01/12 (f) ............................. 4,800,000
Delphi Corp.
4,000,000 06/15/06 (e) ..................................... 4,470,000
5,700,000 05/01/29 (e) ..................................... 6,327,000
Federal-Mogul Corp.
12,000,000 01/15/09 (e) ..................................... 8,940,000
1,000,000 07/01/06 (e) ..................................... 742,500
1,350,000 General Motors Accept Corp.
6.75%, 12/01/14 .................................. 1,388,744
------------
26,668,244
------------
UTILITIES - 0.1%
1,000,000 Enron Corp.11/15/05 (e) (k) ....................... 340,000
------------
WIRELESS - CELLULAR/PCS - 0.5%
3,500,000 Cricket Communications Corp.
9.38%, 11/01/14 (g) .............................. 3,710,000
------------
WIRELESS COMMUNICATIONS - 2.7%
250,000 Clearwire Corp.11.00%, 08/15/10 ................... 251,875
SunCom Wireless Holdings, Inc.
5,000,000 8.50%, 06/01/13 .................................. 4,812,500
1,500,000 8.75%, 11/15/11 .................................. 1,402,500
12,735,000 9.38%, 02/01/11 (h) .............................. 12,034,575
------------
18,501,450
------------
Total Corporate Notes and
Bonds
(Cost $167,189,188) ............................ 183,917,336
------------
10 | See accompanying Notes to Financial Statements.
INVESTMENT PORTFOLIO (CONTINUED)
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
SHARES ($) VALUE ($)
---------- ---------
COMMON STOCKS - 9.0%
21,670 ATP Oil & Gas Corp. (j) ........................... 857,482
82,500 Caremark Rx, Inc. ................................. 4,711,575
33,333 Chesapeake Energy Corp. ........................... 968,324
3,653,116 Delphi Corp. (j) .................................. 13,954,903
28,534 Diamond Offshore Drilling ......................... 2,281,008
18,300 Ferro Corp. ....................................... 378,627
47,500 GlobalSantaFe Corp. ............................... 2,792,050
552,008 Graphic Packaging Corp. (j) ....................... 2,390,195
121,072 Gray Television, Inc., Class A .................... 995,212
357,343 GrayTelevision, Inc. .............................. 2,619,324
225,000 ICO Global Communications
Holding Ltd. (j) ................................. 1,028,250
100,067 Louisiana-Pacific Corp. ........................... 2,154,442
85,816 Newpark Resources, Inc. (j) ....................... 618,733
46,500 Noble Corp. ....................................... 3,540,975
29,800 NRG Energy, Inc. (j) .............................. 1,669,098
177,509 Owens Corning, Inc. (h) (j) ....................... 5,307,507
95,550 Owens Illinois (j) ................................ 1,762,897
136,990 Safety-Kleen Systems, Inc. (j) .................... 3,082,275
41,970 Sprint Nextel Corp. ............................... 792,813
51,500 Triad Hospitals, Inc. (j) ......................... 2,154,245
1,049 Trump Entertainment Resorts, Inc. (j) ............. 19,134
282,085 United Rentals, Inc. (j) .......................... 7,173,422
8 Westgate Investments LLC (j) ...................... 25,000
47,150 Williams Cos., Inc. ............................... 1,231,558
------------
Total Common Stocks
(Cost $58,823,283) ............................. 62,509,049
------------
WARRANTS - 0.0%
20,000 Clearwire Corp., expires 08/15/10
08/15/10 (j) ..................................... 24,200
5,031 OpBiz LLC08/31/10 (j) ............................. 0
10 OpBiz LLC08/31/10 (j) ............................. 0
------------
Total Warrants
(Cost $0) ........................................ 24,200
------------
TOTAL INVESTMENTS - 139.9% ...................................... 969,152,297
------------
(cost of $942,460,716) (l)
OTHER ASSETS & LIABILITIES, NET - (39.9)% ....................... (276,188,460)
------------
NET ASSETS APPLICABLE TO
COMMON SHAREHOLDERS - 100.0% .................................... 692,963,837
============
---------------------------
Investments sold short outstanding as of December 31, 2006:
Equity Securities Shares Value
-------------------------------------------------------
Imperial Sugar Co. 124,162 $ 3,005,961
RadioShack Corp. 70,075 1,175,858
Sharper Image Corp. 84,567 782,244
Superior Industries
International, Inc. 114,720 2,210,654
-----------
Total Investments sold short
(Proceeds $7,248,112) $ 7,174,717
===========
(a) Senior loans in which the Fund invests generally pay interest at rates
which are periodically predetermined by reference to a base lending rate
plus a premium. (Unless otherwise identified by footnote (d), all senior
loans carry a variable rate interest.) These base lending rates are
generally (i) the Prime Rate offered by one or more major U.S. banks, (ii)
the lending rate offered by one or more European banks such as the London
Inter-Bank Offered Rate ("LIBOR") or (iii) the Certificate of Deposit rate.
Rate shown represents the weighted average rate at December 31, 2006.
Senior loans, while exempt from registration under the Security Act of
1933, as amended (the "1933 Act"), contain certain restrictions on resale
and cannot be sold publicly. Senior secured floating rate loans often
require prepayments from excess cash flow or permit the borrower to repay
at its election. The degree to which borrowers repay, whether as a
contractual requirement or at their election, cannot be predicted with
accuracy. As a result, the actual remaining maturity may be substantially
less than the stated maturities shown.
(b) All or a portion of this position has not settled. Contract rates do not
take effect until settlement date.
(c) Senior loan notes have additional unfunded loan commitments. See Note 9.
(d) Fixed rate senior loan.
(e) The issuer is in default of certain debt covenants. Income is not being
accrued.
(f) Floating rate note. The interest rate shown reflects the rate in effect at
December 31, 2006.
(g) Securities exempt from registration pursuant to Rule 144A under the 1933
Act. These securities may only be resold, in transactions exempt from
registration, to qualified institutional buyers. At December 31, 2006, the
value of these securities amounted to $32,919,875 or 4.8% of net assets.
These securities have been determined by the Investment Adviser to be
liquid securities.
(h) Securities (or a portion of securities) on loan as of December 31, 2006.
See Note 8.
(i) Restricted security, e.g., security not registered under the 1933 Act
excluding Rule 144A securities. At December 31, 2006, the value of this
restricted security amounted to $346,500 or 0.1% of net assets. Additional
information about the restricted security is as follows:
Acquition Acquition
Security Date Cost
-----------------------------------------------------------
Doe Run Resources Corp. 08/16/06 $345,188
(j) Non-income producing security.
(k) This issue is under the protection of the Federal Bankruptcy Court.
(l) Cost for federal income tax purposes is $942,470,524.
DIP Debtor in Possession
PIK Payment in Kind
FOREIGN DENOMINATED SENIOR LOAN NOTES
INDUSTRY CONCENTRATION TABLE
(% of Total Net Assets)
Cable - International Cable ......... 3.6%
Retail .............................. 1.8%
Broadcasting ........................ 1.0%
Telecommunications .................. 0.9%
Utilities ........................... 0.4%
-----
Total ............................... 7.7%
=====
See accompanying Notes to Financial Statements. | 11
STATEMENT OF ASSETS AND LIABILITIES
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
($)
-------------------------------------------------------------------------------------------------------------------
ASSETS:
Investments, at value (Cost $942,460,716) ........................................................ 969,152,297
Foreign currency (Cost $10,303,463) .............................................................. 10,321,344
Cash ............................................................................................. 27,828,423
Restricted cash (Note 2) ......................................................................... 3,578,007
Cash held as collateral for securities loaned (Note 8) ........................................... 2,861,357
Net discount and unrealized appreciation on unfunded transactions (Note 9) ....................... 311,932
Receivable for:
Investments sold .............................................................................. 53,115,190
Dividend and interest receivable .............................................................. 11,634
Other assets ..................................................................................... 100,384
---------------
Total assets ............................................................................... 1,067,280,568
---------------
LIABILITIES:
Notes payable (Note 7) ........................................................................... 285,000,000
Securities sold short, at value (Proceeds $7,248,112) ............................................ 7,174,717
Payable upon receipt of securities loaned (Note 8) ............................................... 2,861,357
Payables for:
Payable for investments purchased ............................................................. 76,567,497
Investment advisory fee payable (Note 4) ...................................................... 787,260
Administration fee (Note 4) ................................................................... 157,452
Trustees' fees (Note 4) ....................................................................... 93
Interest expense (Note 7) ..................................................................... 1,251,333
Accrued expenses and other liabilities ........................................................ 517,022
---------------
Total liabilities .......................................................................... 374,316,731
---------------
NET ASSETS APPLICABLE TO COMMON SHARES .............................................................. 692,963,837
===============
COMPOSITION OF NET ASSETS:
Par value of common shares (Note 1) .............................................................. 34,511
Paid-in capital .................................................................................. 657,755,836
Undistributed net investment income .............................................................. 3,769,657
Accumulated net realized gain/(loss) from investments and foreign currency transactions .......... 5,001,473
Net unrealized appreciation/(depreciation) on investments, unfunded transactions,
short positions and translation of assets and liabilities denominated in foreign currency ...... 26,402,360
---------------
NET ASSETS APPLICABLE TO COMMON SHARES AT VALUE ..................................................... 692,963,837
===============
COMMON SHARES:
Net assets ....................................................................................... 692,963,837
Shares outstanding (unlimited authorization) ..................................................... 34,511,355
Net asset value per share (Net assets/shares outstanding) ........................................ 20.08
12 | See accompanying Notes to Financial Statements.
STATEMENT OF OPERATIONS
--------------------------------------------------------------------------------
FOR THE PERIOD ENDED DECEMBER 31, 2006(A) HIGHLAND CREDIT STRATEGIES FUND
($)
-------------------------------------------------------------------------------------------------------------------
INVESTMENT INCOME:
Interest ........................................................................................ 32,842,159
Dividends ....................................................................................... 75,495
Securities lending income ....................................................................... 188,027
--------------
Total investment income ................................................................... 33,105,681
--------------
EXPENSES:
Investment advisory fee (Note 4) ................................................................ 3,879,925
Administration fee (Note 4) ..................................................................... 775,985
Accounting service fee .......................................................................... 189,226
Transfer agent fee .............................................................................. 18,500
Professional fees ............................................................................... 60,500
Trustees' fees (Note 4) ......................................................................... 15,837
Custodian fees .................................................................................. 24,097
Reports to shareholders ......................................................................... 52,597
Other expense ................................................................................... 82,482
--------------
Net operating expenses .................................................................... 5,099,149
--------------
Interest expense (Note 7) ....................................................................... 3,436,058
--------------
Net expenses .............................................................................. 8,535,207
--------------
Net investment income ..................................................................... 24,570,474
--------------
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized gain/(loss) on investments ......................................................... 5,001,473
Net realized gain/(loss) on foreign currency transactions ....................................... (96,257)
Net change in unrealized appreciation/(depreciation) on investments ............................. 26,691,581
Net change in unrealized appreciation/(depreciation) on unfunded transactions (Note 9) .......... 309,552
Net change in unrealized appreciation/(depreciation) on short positions ......................... 73,395
Net change in unrealized appreciation/(depreciation) on translation of assets and
liabilities denominated in foreign currency .................................................. (672,168)
--------------
Net realized and unrealized gain/(loss) on investments .................................... 31,307,576
--------------
Net increase in net assets, applicable to common shareholders ............................. 55,878,050
--------------
----------------------------------------------------
(a) Highland Credit Strategies Fund commenced investment operations on June 29, 2006.
See accompanying Notes to Financial Statements. | 13
STATEMENT OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
HIGHLAND CREDIT STRATEGIES FUND
PERIOD
ENDED
DECEMBER 31,
2006 (A)($)
---------------
INCREASE IN NET ASSETS:
FROM OPERATIONS:
Net investment income .................................................................. 24,570,474
Net realized gain/(loss) on investments and foreign currency transactions .............. 4,905,216
Net change in unrealized appreciation/(depreciation) on investments, unfunded
transactions, short positions and translation of assets and liabilities denominated
in foreign currency .................................................................. 26,402,360
---------------
Net increase in net assets from operations .......................................... 55,878,050
---------------
DISTRIBUTIONS DECLARED TO COMMON SHAREHOLDERS
From net investment income ............................................................. (20,704,560)
---------------
SHARE TRANSACTIONS FROM COMMON SHARES
Subscriptions .......................................................................... 657,570,000
Distributions reinvested ............................................................... 120,347
---------------
Net increase from share transactions ................................................ 657,690,347
---------------
Total increase in net assets from common shares ..................................... 692,863,837
---------------
NET ASSETS APPLICABLE TO COMMON SHARES
Beginning of period .................................................................... 100,000(b)
---------------
End of period (including undistributed net investment income of $3,769,657). ........... 692,963,837
===============
CHANGE IN COMMON SHARES
Subscriptions .......................................................................... 34,500,000
Issued for distributions reinvested .................................................... 6,120
---------------
Net increase ........................................................................ 34,506,120
----------------------------------------------------
(a) Highland Credit Strategies Fund commenced investment operations on June 29, 2006.
(b) Represents initial seed capital.
14 | See accompanying Notes to Financial Statements.
STATEMENT OF CASH FLOWS
--------------------------------------------------------------------------------
FOR THE PERIOD ENDED DECEMBER 31, 2006 (A) HIGHLAND CREDIT STRATEGIES FUND
($)
-------------------------------------------------------------------------------------------------------------------
CASH FLOWS USED FOR OPERATING ACTIVITIES
Net investment income ............................................................................. 24,570,474
ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH AND FOREIGN CURRENCY
USED FOR OPERATING ACTIVITIES
Purchase of investment securities ................................................................. (1,317,754,996)
Increase in restricted cash ....................................................................... 381,326,418
Proceeds from disposition of investment securities ................................................ (3,578,007)
Increase in cash held as collateral for securities loaned ......................................... (2,861,357)
Increase in interest and fees receivable .......................................................... (11,634)
Increase in other assets .......................................................................... (102,765)
Increase in receivable for investments sold ....................................................... (53,115,190)
Increase in securities sold short ................................................................. 7,174,717
Increase in payable upon receipt of securities loaned ............................................. 2,861,357
Increase in payable for investments purchased ..................................................... 76,567,497
Net amortization/(accretion) of premium/(discount) ................................................ (1,030,664)
Decease in market to market on realized and unrealized gain/(loss) on foreign currency ............ (768,425)
Increase in unrealized appreciation/(depreciation) on securities sold short ....................... 73,395
Increase in payables to related parties ........................................................... 944,805
Increase in other expenses and liabilities ........................................................ 517,022
---------------
Net cash and foreign currency flow from operating activities ................................ (885,187,353)
---------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Increase in notes payable ......................................................................... 285,000,000
Increase in interest payable ...................................................................... 1,251,333
Proceeds from shares sold ......................................................................... 657,570,000
Distributions paid in cash ........................................................................ (20,584,213)
---------------
Net cash flow provided by financing activities .............................................. 923,237,120
---------------
Net increase in cash and foreign currency ................................................... 38,049,767
CASH AND FOREIGN CURRENCY
Beginning of the period ........................................................................... 100,000(b)
End of the period ................................................................................. 38,149,767
===============
----------------------------------------------------
(a) Highland Credit Strategies Fund commenced investment operations on June 29, 2006.
(b) Represents initial seed capital.
See accompanying Notes to Financial Statements. | 15
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
HIGHLAND CREDIT STRATEGIES FUND
SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
FOR THE PERIOD
COMMON SHARES PER SHARE OPERATING PERFORMANCE: ENDED 12/30/06(A)
NET ASSET VALUE, BEGINNING OF PERIOD $ 19.06
-------------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income 0.71
Net realized and unrealized gain on investments 0.91
-------------
Total from investment operations, applicable to common shareholders 1.62
LESS DISTRIBUTIONS DECLARED TO COMMON SHAREHOLDERS:
From net investment income (0.60)
-------------
-------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 20.08
MARKET VALUE, END OF PERIOD $ 21.16
Market Value Total Return (c) 9.06%(b)
-------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
COMMON SHARE INFORMATION AT END OF PERIOD:
Ratios based on net assets of common shares
Net assets, end of period (in 000's) $ 692,964
Net operating expenses 1.31%
Interest expenses 0.89%
Net expenses 2.20%
Net investment income 6.33%
Portfolio turnover rate 45.95%(b)
----------------------------------------------------
(a) Highland Credit Strategies Fund commenced investment operations on June 29,
2006.
(b) Not annualized.
(c) Based on market value per share. Dividends and distributions, if any, are
assumed for purposes of this calculation to be reinvested at prices obtained
under the Fund's reinvestment plan.
16 | See accompanying Notes to Financial Statements.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
NOTE 1. ORGANIZATION
Highland Credit Strategies Fund (the "Fund") is a Delaware statutory trust
registered under the Investment Company Act of 1940, as amended (the "1940
Act"), as a nondiversified, closed-end management investment company. The Fund
may issue an unlimited number of common shares, par value $0.001 per share
("Common Shares").
INVESTMENT GOAL
The Fund seeks to provide both current income and capital appreciation.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles ("GAAP") requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements.
FUND VALUATION
The net asset value of the Fund's Common Shares is calculated daily on each day
that the New York Stock Exchange is open for business as of the close of the
regular trading session on the New York Stock Exchange. The net asset value is
calculated by dividing the value of the Fund's net assets attributable to Common
Shares by the number of Common Shares outstanding.
SECURITY VALUATION
In computing the Fund's net assets attributable to Common Shares, securities
with readily available market quotations use those quotations for valuation.
When portfolio securities are traded on the relevant day of valuation, the
valuation will be the last reported sale price on that day. If there are no such
sales on that day, the security will be valued at the mean between the most
recently quoted bid and asked prices provided by the principal market makers. If
there is more than one such principal market maker, the value shall be the
average of such means. Securities without a sale price or quotations from
principal market makers on the valuation day will be valued by an independent
pricing service. If securities do not have readily available market quotations
or pricing service prices, including circumstances under which such are
determined not to be accurate or current (including when events materially
affect the value of securities occurring between the time when market price is
determined and calculation of the Fund's net asset value), such securities are
valued at their fair value, as determined by Highland Capital Management, L.P.
("Highland" or the "Investment Adviser") in good faith in accordance with
procedures approved by the Fund's Board of Trustees. In these cases, the Fund's
net asset value will reflect the affected portfolio securities' value as
determined in the judgment of the Board of Trustees or its designee instead of
being determined by the market. Using a fair value pricing methodology to value
securities may result in a value that is different from a security's most recent
sale price and from the prices used by other investment companies to calculate
their net asset values. There can be no assurance that the Fund's valuation of a
security will not differ from the amount that it realizes upon the sale of such
security. Short-term investments, that is, those with a remaining maturity of 60
days or less, are valued at amortized cost. Repurchase agreements are valued at
cost plus accrued interest. Foreign price quotations are converted to U.S.
dollar equivalents using the 4 PM London Time Spot Rate.
SECURITY TRANSACTIONS
Security transactions are accounted for on the trade date. Cost is determined
and gains (losses) are based upon the specific identification method for both
financial statement and federal income tax purposes.
FOREIGN CURRENCY
Foreign currencies, investments and other assets and liabilities are translated
into U.S. dollars at the exchange rates using the current 4:00 PM London Time
Spot Rate. Fluctuations in the value of the foreign currencies and other assets
and liabilities resulting from changes in exchange rates between trade and
settlement dates on security transactions and between the accrual and payment
dates on dividends, interest income and foreign withholding taxes are recorded
as unrealized foreign currency gains (losses). Realized gains (losses) and
unrealized appreciation (depreciation) on investment securities and income and
expenses are translated on the respective dates of such transactions. The effect
of changes in foreign currency exchange rates on investments in securities are
not segregated in the Statement of Operations from the effects of changes in
market prices of those securities, but are included with the net realized and
unrealized gain or loss on investment securities.
SHORT SALES
A short sale is a transaction in which the Trust sells a security it does not
own in anticipation that the market price of that security will decline. When
the Trust makes a short
Annual Report | 17
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
sale, it must borrow the security sold short from a broker-dealer and deliver it
to the buyer upon conclusion of the sale. The Trust may have to pay a fee to
borrow particular securities and is often obligated to pay over any payments
received on such borrowed securities. Cash held as collateral for short sales is
classified as restricted cash on the Statement of Assets and Liabilities.
The Trust intends to attempt to limit exposure to a possible market decline in
the value of its portfolio securities through short sales of securities that
Highland believes possess volatility characteristics similar to those being
hedged. In addition, the Trust intends to use short sales for non-hedging
purposes to pursue its investment objectives. Subject to the requirements of the
1940 Act and the Internal Revenue Code of 1986, as amended (the "Code"), the
Trust will not make a short sale if, after giving effect to such sale, the
market value of all securities sold short by the Trust exceeds 25% of the value
of its total assets.
INCOME RECOGNITION
Interest income i recorded on the accrual basis and includes accretion of
discounts and amortization of premiums. Dividend income is recorded on the
ex-dividend date.
FEDERAL INCOME TAX STATUS
The Fund intends to qualify each year as a "regulated investment company" under
Subchapter M of the Code, and will distribute substantially all of its taxable
income and gains, if any, for its tax year, and as such will not be subject to
federal income taxes. In addition, the Fund intends to distribute, in each
calendar year, all of its net investment income, capital gains and certain other
amounts, if any, such that the Fund should not be subject to federal excise tax.
Therefore, no federal income or excise tax provisions are recorded.
DIVIDENDS AND DISTRIBUTIONS
The Fund plans to pay dividend distributions monthly and capital gain
distributions annually to common shareholders. To permit the Fund to maintain
more stable monthly dividends and annual distributions, the Fund may from time
to time distribute less than the entire amount of income and gains earned in the
relevant month or year, respectively. The undistributed income and gains would
be available to supplement future distributions. Shareholders of the Fund will
automatically have all dividends and distributions reinvested in Common Shares
of the Fund issued by the Fund or purchased in the open market in accordance
with the Fund's Dividend Reinvestment Plan (the "Plan") unless an election is
made to receive cash. Each participant in the Plan will pay a pro rata share of
brokerage commissions incurred in connection with open market purchases, and
participants requesting a sale of securities through the plan agent of the Plan
are subject to a sales fee and a brokerage commission.
STATEMENT OF CASH FLOWS
Information on financial transactions which have been settled through the
receipt or disbursement of cash is presented in the Statement of Cash Flows. The
cash and foreign currency amount shown in the Statement of Cash Flows is the
amount included within the Fund's Statement of Assets and Liabilities and
includes cash and foreign currency on hand at its custodian bank.
ADDITIONAL ACCOUNTING STANDARDS
On July 13, 2006, the Financial Accounting Standards Board (FASB) released FASB
Interpretation No. 48 (FIN 48) "Accounting for Uncertainty in Income Taxes". FIN
48 provides guidance for how uncertain tax positions should be recognized,
measured, presented and disclosed in the financial statements. FIN 48 requires
the evaluation of tax positions taken in the course of preparing the Fund's tax
returns to determine whether the tax positions are "more-likely-than-not" of
being sustained by the applicable tax authority. Tax benefits of positions not
deemed to meet the more-likely-than-not threshold would be booked as a tax
expense in the current year and would be recognized as: a liability for
unrecognized tax benefits; a reduction of an income tax refund receivable; a
reduction of deferred tax asset; an increase in deferred tax liability; or a
combination thereof. Adoption of FIN 48 is required for fiscal years beginning
after December 15, 2006.
In addition, in September 2006, Statement of Financial Accounting Standards No.
157 FAIR VALUE MEASUREMENTS ("SFAS 157") was issued and is effective for fiscal
years beginning after November 15, 2007. SFAS 157 defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements.
At this time, management is evaluating the implications of FIN 48 and SFAS 157
and their impact on the financial statements have not yet been determined.
NOTE 3. FEDERAL TAX INFORMATION
The timing and character of income and capital gain distributions are determined
in accordance with income tax regulations, which may differ from GAAP. As a
result, net investment income (loss) and net realized gain (loss) on investment
transactions for a reporting period may differ significantly from distributions
during such period.
Reclassifications are made to the Fund's capital accounts for permanent tax
differences to reflect income and gains available for distribution (or available
capital loss carryforwards) under income tax regulations.
18 | Annual Report
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
For the year ended December 31, 2006, permanent differences resulting primarily
from section 988 gain/(loss) reclass were identified and reclassified among the
components of the Fund's net assets as follows:
Overdistributed
Net Investment Accumulated Net
Income Realized Loss
$ (96,257) $96,257
Net investment income and net realized gains (losses), as disclosed on the
Statement of Operations, and net assets were not affected by these
reclassifications.
The tax character of distributions paid during the year ended December 31, 2006
was as follows:
Distributions paid from: 2006
Ordinary income* $20,704,560
Long-term capital gains --
*For tax purposes, short-term capital gains distributions, if any, are
considered ordinary income distributions.
As of December 31, 2006, the components of distributable earnings on a tax basis
were as follows:
Undistributed Undistributed
Ordinary Long-Term Net Unrealized
Income Capital Gains Depreciation*
$ 8,780,938 $-- $ 26,392,552
*Any differences between book-basis and tax-basis net unrealized
appreciation/depreciation are primarily due to deferral of losses from wash
sales.
Unrealized appreciation and depreciation at December 31, 2006, based on cost of
investments for federal income tax purposes and excluding any unrealized
appreciation and depreciation from changes in the value of other assets and
liabilities resulting from changes in exchange rates, was:
Unrealized appreciation $ 29,689,165
Unrealized depreciation (3,007,392)
------------
Net unrealized appreciation $ 26,681,773
============
NOTE 4. INVESTMENT ADVISER, ADMINISTRATION, AND TRUSTEE FEES
INVESTMENT ADVISER FEE
Highland Capital Management, L.P is the investment adviser to the Fund and
receives an annual fee, paid monthly, in an amount equal to 1.00% of the average
weekly value of the Fund's Managed Assets. The Fund's "Managed Assets" is an
amount equal to the total assets of the Fund, including any form of leverage,
minus all accrued expenses incurred in the normal course of operations, but not
excluding any liabilities or obligations attributable to investment leverage
obtained through (i) indebtedness of any type (including, without limitation,
borrowing through a credit facility or the issuance of debt securities), (ii)
the issuance of preferred stock or other preference securities, (iii) the
reinvestment of collateral received for securities loaned in accordance with the
Fund's investment objectives and policies, and/or (iv) any other means.
ADMINISTRATION FEE
Highland provides administrative services to the Fund. For its services,
Highland receives an annual fee, payable monthly, in an amount equal to 0.20% of
the average weekly value of the Fund's Managed Assets. Under a separate
sub-administration agreement, Highland has delegated certain administrative
functions to PFPC Inc. ("PFPC"). Highland pays PFPC directly for these
sub-administration services.
FEES PAID TO TRUSTEES
The Fund pays no compensation to its Trustee and Officers who are interested
persons (as defined in the 1940 Act) of the Fund and employees of Highland. The
Fund pays each Trustee who is not an interested person (as defined in the 1940
Act) of the Fund an annual retainer of $7,500 per year for services provided as
a Trustee of the Fund.
NOTE 5. PORTFOLIO INFORMATION
For the period ended December 31, 2006, the cost of purchases and proceeds from
sales of securities, excluding short-term obligations, were $1,317,754,996 and
$381,326,418, respectively.
NOTE 6. SENIOR LOAN PARTICIPATION COMMITMENTS
The Fund may invest its assets (plus any borrowings for investment purposes) in
adjustable rate senior loans ("Senior Loans") the interest rates of which float
or vary periodically based upon a benchmark indicator of prevailing interest
rates to domestic or foreign corporations, partnerships and other entities
("Borrowers"). If the lead lender in a typical lending syndicate becomes
insolvent, enters FDIC receivership or, if not FDIC, insured enters into
bankruptcy, the Fund may incur certain costs and delays in receiving payment or
may suffer a loss of principal and/or interest. When the Fund purchases a
participation of a Senior Loan interest, the Fund typically enters into a
contractual agreement with the lender or other third party selling the
participation (the "Selling Participant"), not with the Borrower directly. As
such, the Fund assumes the credit risk of the Borrower, Selling Participant or
other persons interpositioned between the Fund and the Borrower. The ability of
Borrowers to meet their obligations may be affected by eco-
Annual Report | 19
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
nomic developments in a specific industry. At December 31, 2006, there were no
Senior Loans purchased by the Fund on a participation basis.
NOTE 7. LOAN AGREEMENT
Effective August 3, 2006, the Fund entered into a $300,000,000 secured loan
agreement with Scotia Capital ("Scotia").
At December 31, 2006, the Fund had a term loan outstanding with Scotia, totaling
$285,000,000. The interest rate charged on this loan at December 31, 2006 was
5.37%. The average daily loan balance was $183,771,186 at weighted average
interest rate of 5.34%. The Fund was required to maintain certain asset coverage
with respect to the loan. Interest expense of $3,436,058 is included on the
Statement of Operations.
The Fund is required to maintain 300% asset coverage with respect to amounts
outstanding under the agreement. The loan agreement asset coverage is calculated
by subtracting the Fund's total liabilities, not including any bank loans and
senior securities, from the Fund's total net assets and dividing such amount by
the principal amount of the debt outstanding and is as follows:
Asset Coverage
Total Amount per $1,000 of
Date Outstanding Indebtness
12/31/2006 $285,000,000 $3,429
NOTE 8. SECURITIES LOANS
The Fund may make secured loans of its portfolio securities amounting to not
more than one-third of the value of its total assets, thereby realizing
additional income. The risks in lending portfolio securities, as with other
extensions of credit, consist of possible delays in recovery of the securities
or possible loss of rights in the collateral should the borrower fail
financially. As a matter of policy, securities loans are made to unaffiliated
broker-dealers pursuant to agreements requiring that loans be continuously
secured by collateral in cash or short-term debt obligations at least equal at
all times to the value of the securities subject to the loan. The borrower pays
to the Fund an amount equal to any interest or dividends received on securities
subject to the loan. The Fund retains all or a portion of the interest received
on investment of the cash collateral or receives a fee from the borrower. As of
December 31, 2006, the value of securities loaned by the Fund was $2,793,238.
The loans were secured with cash collateral of $2,861,357.
9. UNFUNDED LOAN COMMITMENTS
As of December 31, 2006, the Fund had unfunded loan commitments of $11,326,092,
which could be extended at the option of the borrower, pursuant to the following
loan agreements:
Unfunded
Loan
Borrower Commitment
Ammsterdamse Beheer - En
Consultingmaatschappu BV (Cassena) $ 6,500,000
Drake Hotel Acquisition 1,309,386
Ferro Corp. 1,111,111
Millennium Digial Media Systems, LLC 1,238,322
Oglebay Norton Co. 400,000
Persona Communications Corp. 767,273
-------------
$ 11,326,092
=============
NOTE 10. DISCLOSURE OF SIGNIFICANT RISKS AND CONTINGENCIES
INDUSTRY FOCUS
The Fund may focus its investments in instruments of only a few companies. The
concentration of the Fund's portfolio in any one obligor would subject the Fund
to a greater degree of risk with respect to defaults by such obligor, and the
concentration of the portfolio in any one industry would subject the Fund to a
greater degree of risk with respect to economic downturns relating to such
industry.
NON-PAYMENT RISK
Corporate debt obligations, including Senior Loans, are subject to the risk of
non-payment of scheduled interest and/or principal. Non-payment would result in
a reduction of income to the Fund, a reduction in the value of the Senior Loan
experiencing non-payment, and a potential decrease in the net asset value of the
Fund.
CREDIT RISK
Investments rated below investment grade are commonly referred to as high-yield,
high risk or "junk debt." They are regarded as predominantly speculative with
respect to the issuing company's continuing ability to meet principal and/or
interest payments. Investments in high yield Senior Loans may result in greater
net asset value fluctuation than if the Fund did not make such investments.
20 | Annual Report
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
DECEMBER 31, 2006 HIGHLAND CREDIT STRATEGIES FUND
ILLIQUIDITY OF INVESTMENTS
The investments made by the Fund may be illiquid, and consequently the Fund may
not be able to sell such investments at prices that reflect the Investment
Adviser's assessment of their value or the amount originally paid for such
investments by the Fund. Illiquidity may result from the absence of an
established market for the investments as well as legal, contractual or other
restrictions on their resale and other factors. Furthermore, the nature of the
Fund's investments, especially those in financially distressed companies, may
require a long holding period prior to profitability.
TROUBLED, DISTRESSED OR BANKRUPT COMPANIES
The Fund invests in companies that are troubled, in distress, or bankrupt. As
such, they are subject to a multitude of legal, industry, market, environment
and governmental forces that make analysis of these companies inherently risky.
Further, the Investment Adviser relies on company management, outside experts,
market participants, and personal experience to analyze potential investments
for the Fund. There can be no assurance that any of these sources will prove
credible, or that the resulting analysis will produce accurate conclusions.
LEVERAGE RISK
The Fund intends to use leverage through the issuance of preferred shares,
borrowings from a credit facility, or both. The use of leverage, which can be
described as exposure to changes in price at a ratio greater than the amount of
equity invested, either through the issuance of preferred shares, borrowing or
other forms of market exposure, magnifies both the favorable and unfavorable
effects of price movements in the investments made by the Fund. Insofar as the
Fund employs leverage in its investment operations, the Fund will be subject to
substantial risks of loss.
FOREIGN SECURITIES
Investments in foreign securities involve certain factors not typically
associated with investing in U.S. securities, such as risks relating to (i)
currency exchange matters, including fluctuations in the rate of exchange
between the U.S. dollar (the currency in which the books of the Fund are
maintained) and the various foreign currencies in which the Fund's portfolio
securities will be denominated and costs associated with conversion of
investment principal and income from one currency into another; (ii) differences
between the U.S. and foreign securities markets, including the absence of
uniform accounting, auditing and financial reporting standards and practices and
disclosure requirements, and less government supervision and regulation; (iii)
political, social or economic instability; and (iv) the extension of credit,
especially in the case of sovereign debt.
EMERGING MARKETS RISK
Investing in securities of issuers based in underdeveloped emerging markets
entails all of the risks of investing in foreign securities to a heightened
degree. These heightened risks include: (i) greater risks of expropriation,
confiscatory taxation, nationalization, and less social political and economic
stability; (ii) the smaller size of the markets for such securities and a lower
volume of trading, resulting in lack of liquidity and in price volatility; and
(iii) certain national policies which may restrict the Fund's investment
opportunities including restrictions on investing in issuers or industries
deemed sensitive to relevant national interest.
DERIVATIVES RISK
Derivative transactions in which the Fund may engage for hedging and speculative
purposes or to enhance total return, including engaging in transactions such as
options, futures, swaps, foreign currency transactions including forward foreign
currency contracts, currency swaps or options on currency and currency futures
and other derivative transactions, involve certain risks and considerations.
These risks include the imperfect correlation between the value of such
instruments and the underlying assets, the possible default of the other party
to the transaction or illiquidity of the derivative instruments. Furthermore,
the ability to successfully use derivative transactions depends on the
Investment Adviser's ability to predict pertinent market movements, which can
not be assured. Thus, the use of derivative transactions may result in losses
greater than if they had not been used, may require the Fund to sell or purchase
portfolio securities at inopportune times or for prices other than current
market value, may limit the amount of appreciation the Fund can realize on an
investment or may cause the Fund to hold a security that it might otherwise
sell.
SHORT SALES RISK
Short selling involves selling securities which may or may not be owned and
borrowing the same securities for delivery to the purchaser, with an obligation
to replace the borrowed securities at a later date. The Fund will profit from
declines in the market prices to the extent such decline exceeds the transaction
costs and the costs of borrowing the securities. However, since the borrowed
securities must be replaced by purchases at market prices in order to close out
the short position, any appreciation in the price of the borrowed securities
would result in a loss. There can be no assurance that the securities necessary
to cover a short position will be available for purchase.
Annual Report | 21
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------------------------------
TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF HIGHLAND CREDIT STRATEGIES FUND:
In our opinion, the accompanying statement of assets and liabilities, including
the investment portfolio, and the related statements of operations and of
changes in net assets and of cash flows and the financial highlights present
fairly, in all material respects, the financial position of Highland Credit
Strategies Fund (the "Fund") at December 31, 2006, and the results of its
operations, the changes in its net assets and cash flows and the financial
highlights for the period from June 29, 2006 (commencement of operations)
through December 31, 2006 in conformity with accounting principles generally
accepted in the United States of America. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these financial statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audit, which included confirmation
of investments at December 31, 2006 by correspondence with the custodian and the
banks with whom the Fund owns participations in loans, provides a reasonable
basis for our opinion.
PricewaterhouseCoopers LLP
Dallas, Texas
February 26, 2007
22 | Annual Report
ADDITIONAL INFORMATION (UNAUDITED)
--------------------------------------------------------------------------------
DIVIDEND REINVESTMENT PLAN HIGHLAND CREDIT STRATEGIES FUND
Unless the registered owner of Common Shares elects to receive cash by
contacting the Plan Agent, all dividends declared for your Common Shares of the
Trust will be automatically reinvested by PFPC, Inc. (the ""Plan Agent"), agent
for shareholders in administering the Trust's Dividend Reinvestment Plan (the
""Plan"), in additional Common Shares of the Trust. If a registered owner of
Common Shares elects not to participate in the Plan, you will receive all
dividends in cash paid by check mailed directly to you (or, if the shares are
held in street or other nominee name, then to such nominee) by PFPC, Inc., as
dividend disbursing agent. You may elect not to participate in the Plan and to
receive all dividends in cash by sending written instructions or by contacting
PFPC, Inc., as dividend disbursing agent, at the address set forth below.
Participation in the Plan is completely voluntary and may be terminated or
resumed at any time without penalty by contacting the Plan Agent before the
dividend record date; otherwise such termination or resumption will be effective
with respect to any subsequently declared dividend or other distribution. Some
brokers may automatically elect to receive cash on your behalf and may re-invest
that cash in additional Common Shares of the Trust for you.
The Plan Agent will open an account for each common shareholder under the Plan
in the same name in which such Common Shareholder's Common Shares are
registered. Whenever the Trust declares a dividend or other distribution
(together, a ""dividend") payable in cash, non-participants in the Plan will
receive cash and participants in the Plan will receive the equivalent in Common
Shares. The Common Shares will be acquired by the Plan Agent for the
participants' accounts, depending upon the circumstances described below, either
(i) through receipt of additional unissued but authorized Common Shares from the
Trust (""newly issued Common Shares") or (ii) by purchase of outstanding Common
Shares on the open market (""open-market purchases") on the New York Stock
Exchange or elsewhere.
If, on the payment date for any dividend, the market price per Common Share plus
estimated brokerage commissions is greater than the net asset value per Common
Share (such condition being referred to herein as ""market premium"), the Plan
Agent will invest the dividend amount in newly issued Common Shares, including
fractions, on behalf of the participants. The number of newly issued Common
Shares to be credited to each participant's account will be determined by
dividing the dollar amount of the dividend by the net asset value per Common
Share on the payment date; provided that, if the net asset value per Common
Share is less than 95% of the market price per Common Share on the payment date,
the dollar amount of the dividend will be divided by 95% of the market price per
Common Share on the payment date.
If, on the payment date for any dividend, the net asset value per Common Share
is greater than the market value per Common Share plus estimated brokerage
commissions (such condition being referred to herein as ""market discount"), the
Plan Agent will invest the dividend amount in Common Shares acquired on behalf
of the participants in open-market purchases.
In the event of a market discount on the payment date for any dividend, the Plan
Agent will have until the last business day before the next date on which the
Common Shares trade on an ""ex-dividend" basis or 120 days after the payment
date for such dividend, whichever is sooner (the ""last purchase date"), to
invest the dividend amount in Common Shares acquired in open-market purchases.
It is contemplated that the Trust will pay monthly dividends. Therefore, the
period during which open-market purchases can be made will exist only from the
payment date of each dividend through the date before the ""ex-dividend" date of
the third month of the quarter. If, before the Plan Agent has completed its
open-market purchases, the market price of a Common Share exceeds the net asset
value per Common Share, the average per Common Share purchase price paid by the
Plan Agent may exceed the net asset value of the Common Shares, resulting in the
acquisition of fewer Common Shares than if the dividend had been paid in newly
issued Common Shares on the dividend payment date. Because of the foregoing
difficulty with respect to open market purchases, if the Plan Agent is unable to
invest the full dividend amount in open market purchases during the purchase
period or if the market discount shifts to a market premium during the purchase
period, the Plan Agent may cease making open-market purchases and may invest the
uninvested portion of the dividend amount in newly issued Common Shares at the
net asset value per Common Share at the close of business on the last purchase
date; provided that, if the net asset value per Common Share is less than 95% of
the market price per Common Share on the payment date, the dollar amount of the
dividend will be divided by 95% of the market price per Common Share on the
payment date.
The Plan Agent maintains all shareholders' accounts in the Plan and furnishes
written confirmation of all transactions in the accounts, including information
needed by shareholders for tax records. Common Shares in the account of each
Plan participant will be held by the Plan Agent on behalf of the Plan
participant, and each shareholder proxy will include those shares purchased or
received pursuant to the Plan. The Plan Agent will forward all proxy
solicitation materials to participants and vote proxies for shares held under
the Plan in accordance with the instructions of the participants.
In the case of shareholders such as banks, brokers or nominees which hold shares
for others who are the beneficial owners, the Plan Agent will administer the
Plan on the basis of the number of Common Shares certified from time to time by
the record shareholder's name and held for the account of beneficial owners who
participate in the Plan.
Annual Report | 23
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
DIVIDEND REINVESTMENT PLAN (CONTINUED) HIGHLAND CREDIT STRATEGIES FUND
There will be no brokerage charges with respect to Common Shares issued directly
by the Trust. However, each participant will pay a pro rata share of brokerage
commissions incurred in connection with open-market purchases. The automatic
reinvestment of dividends will not relieve participants of any federal, state or
local income tax that may be payable (or required to be withheld) on such
dividends. Accordingly, any taxable dividend received by a participant that is
reinvested in additional Common Shares will be subject to federal (and possibly
state and local) income tax even though such participant will not receive a
corresponding amount of cash with which to pay such taxes. See "Tax Matters."
Participants who request a sale of shares through the Plan Agent are subject to
a $2.50 sales fee and pay a brokerage commission of $0.05 per share sold.
The Trust reserves the right to amend or terminate the Plan. There is no direct
service charge to participants in the Plan; however, the Trust reserves the
right to amend the Plan to include a service charge payable by the participants.
All correspondence concerning the Plan should be directed to the Plan Agent at
PFPC, Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809; telephone (877)
665-1287.
24 | Annual Report
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FEBRUARY 26, 2007 HIGHLAND CREDIT STRATEGIES FUND
TRUSTEES AND OFFICERS
The Trustees and officers serve terms of indefinite duration. The names and ages
of the Trustees and officers of the Fund, the year each was first elected or
appointed to office, their principal business occupations during at least the
last five years, the number of portfolios overseen by each Trustee and other
directorships they hold are shown below. Each officer listed below serves as an
officer of each Fund in the Highland Fund Complex. The business address of the
Trustees and officers is c/o Highland Capital Management, L.P. Two Galleria
Tower, 13455 Noel Road, Suite 800, Dallas, TX 75240.
YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS
ELECTED OR OCCUPATION(S) IN HIGHLAND FUND OTHER
POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS
NAME AND AGE WITH FUND TO OFFICE 1 FIVE YEARS BY TRUSTEE 2 HELD
INDEPENDENT TRUSTEES
Timothy K. Hui Trustee 2006 Dean of Educational Resources 10 None
(Age 58) since July 2006; Assistant
Provost for Graduate Education
since July 2004; Assistant
Provost for Educational
Resources, July 2001 to June
2004, Philadelphia Biblical
University.
Scott F. Kavanaugh Trustee 2006 Private Investor since February 10 None
(Age 46) 2004; Sales Representative at
Round Hill Securities, March
2003 to January 2004;
Executive at Provident Funding
Mortgage Corporation, February
2003 to July 2003; Executive
Vice President, Director and
Treasurer, Commercial Capital
Bank, January 2000 to February
2003; Managing Principal and
Chief Operating Officer,
Financial Institutional Partners
Mortgage Company and the
Managing Principal and
President of Financial
Institutional Partners, LLC (an
investment banking firm), April
1998 to February 2003.
James F. Leary Trustee 2006 Managing Director, Benefit 10 Board Member of
(Age 76) Capital Southwest, Inc. (a finan- Capstone Series
cial consulting firm) since Fund, Inc.
January 1999.
Bryan A. Ward Trustee 2006 Senior Manager, Accenture, LLP 10 None
(Age 52) (a consulting firm) since January
2002.
1 After a Trustee's initial term, each Trustee is expected to serve a three-year
term concurrent with the Class of Trustees for which he serves. Messrs. Leary
and Ward, as Class I Trustees, are expected to stand for re-election in 2007;
Messrs. Hui and Kavanaugh, as Class II Trustees, are expected to stand for
re-election in 2008; and Mr. Dougherty, the sole Class III Trustee, is
expected to stand for re-election in 2009.
2 The Highland Fund Complex means all of the registered investment companies
advised by the Investment Adviser as of the date of this table.
Annual Report | 25
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FEBRUARY 26, 2007 HIGHLAND CREDIT STRATEGIES FUND
TRUSTEES AND OFFICERS
YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS
ELECTED OR OCCUPATION(S) IN HIGHLAND FUND OTHER
POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS
NAME AND AGE WITH FUND TO OFFICE 1 FIVE YEARS BY TRUSTEE 2 HELD
INTERESTED TRUSTEE 3
R. Joseph Dougherty Trustee and 2006 Senior Portfolio Manager of the 10 None
(Age 36) Chairman of the Investment Adviser since 2000.
Board Trustee and Senior Vice
President of the funds in the
Highland Fund Complex.
OFFICERS 4
James D. Dondero Chief Executive 2006 President and Director of Strand N/A N/A
(Age 44) Officer and Advisors, Inc., ("Strand") the
President General Partner of the
Investment Adviser. President of
the funds in the Highland Fund
Complex.
R. Joseph Dougherty Senior Vice 2006 Senior Portfolio Manager of the N/A N/A
(Age 36) President Investment Adviser since 2000.
Mark Okada Executive Vice 2006 Executive Vice President of N/A N/A
(Age 44) President Strand and the funds in the
Highland Fund Complex; Chief
Investment Officer of the
Investment Adviser.
M. Jason Blackburn Chief Financial 2006 Assistant Controller of the N/A N/A
(Age 30) Officer (Principal Investment Adviser since
Accounting Officer), November 2001. Treasurer and
Treasurer and Secretary of the funds in the
Secretary Highland Fund Complex.
Michael S. Minces Chief Compliance 2006 Chief Compliance Officer of the N/A N/A
(Age 32) Officer Investment Adviser and the
funds in the Highland Fund
Complex since August 2004;
Associate, Akin Gump Strauss
Hauer & Feld LLP (law firm),
October 2003 to August 2004;
Associate, Skadden, Arps,
Slate, Meagher & Flom LLP
(law firm), October 2000 to
March 2003.
1 After a Trustee's initial term, each Trustee is expected to serve a three-year
term concurrent with the Class of Trustees for which he serves. Messrs. Leary
and Ward, as Class I Trustees, are expected to stand for re-election in 2007;
Messrs. Hui and Kavanaugh, as Class II Trustees, are expected to stand for
re-election in 2008; and Mr. Dougherty, the sole Class III Trustee, is
expected to stand for re-election in 2009.
2 The Highland Fund Complex means all of the registered investment companies
advised by the Investment Adviser as of the date of this table.
3 Mr. Dougherty is deemed to be an "interested person" of the Fund under the
1940 Act because of his position with Highland.
4 Each officer also serves in the same capacity for each fund in the Highland
Fund Complex.
26 | Annual Report
IMPORTANT INFORMATION ABOUT THIS REPORT
--------------------------------------------------------------------------------
TRANSFER AGENT
PFPC Inc.
101 Sabin Street
Pawtucket, RI 02860
INVESTMENT ADVISER
Highland Capital Management, L.P.
13455 Noel Road, Suite 800
Dallas, TX 75240
INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
PricewaterhouseCoopers LLP
2001 Rose Avenue, Suite 1800
Dallas, TX 75201
CUSTODIAN
PFPC Trust Company
8800 Tinicum Boulevard
Philadelphia, PA 19153
The Fund mails one shareholder report to each shareholder address. If you would
like more than one report, please call shareholder services at 1-877-665-1287
and additional reports will be sent to you.
This report has been prepared for shareholders of Highland Credit Strategies
Fund.
A description of the policies and procedures that the Fund uses to determine how
to vote proxies relating to its portfolio securities, and the Fund's proxy
voting record for the most recent 12-month period ended June 30, are available
(i) without charge, upon request, by calling 1-877-665-1287 and (ii) on the
Securities and Exchange Commission's website at http://www.sec.gov.
The Fund files its complete schedule of portfolio holdings with the
Securities and Exchange Commission for the first and third quarters of each
fiscal year on Form N-Q. The Fund's Forms N-Q are available on the Commission's
website at http://www.sec.gov and also may be reviewed and copied at the
Commission's Public Reference Room in Washington, DC. Information on the Public
Reference Room may be obtained by calling 1-800-SEC-0330.
The Statement of Additional Information includes additional information about
the Fund's Trustees and is available upon request without charge by calling
1-877-665-1287.
Annual Report | 27
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HIGHLAND CREDIT STRATEGIES FUND - HCF Annual Report - December 31, 2006
[GRAPHIC OMITTED - SHIELD]
HIGHLAND FUNDS
managed by Highland Capital Management, L.P.
www.highlandfunds.com HLC-HCF AR-12/06
ITEM 2. CODE OF ETHICS.
(a) The registrant, as of the end of the period covered by this report, has
adopted a code of ethics that applies to the registrant's principal
executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions,
regardless of whether these individuals are employed by the registrant
or a third party.
(b) Not applicable.
(c) There have been no amendments, during the period covered by this
report, to a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are employed
by the registrant or a third party, and that relates to any element of
the code of ethics description.
(d) The registrant has not granted any waivers, including an implicit
waiver, from a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are employed
by the registrant or a third party, that relates to one or more of the
items set forth in paragraph (b) of this item's instructions.
(e) Not applicable.
(f) Code of ethics filed herewith.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
As of the end of the period covered by the report, the registrant's board of
trustees has determined that James Leary is qualified to serve as an audit
committee financial expert serving on its audit committee and that he is
"independent," as defined by Item 3 of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
AUDIT FEES
(a) The aggregate fees billed from the Registrant's inception on June 29,
2006 through December 31, 2006 for professional services rendered by
the principal accountant for the audit of the registrant's annual
financial statements or services that are normally provided by the
accountant in connection with statutory and regulatory filings or
engagements was $42,000.
AUDIT-RELATED FEES
(b) The aggregate fees billed from the Registrant's inception on June 29,
2006 through December 31, 2006 for assurance and related services by
the principal accountant that are reasonably related to the performance
of the audit of the registrant's financial statements and are not
reported under paragraph (a) of this Item was $5,500. These services
consisted of a review of semi-annual regulatory filing.
TAX FEES
(c) The aggregate fees billed from the Registrant's inception on June 29,
2006 through December 31, 2006 for professional services rendered by
the principal accountant for tax compliance, tax advice, and tax
planning was $5,000. These services consisted of (i) review and/or
preparation of U.S. federal, state, local and excise tax returns; and
(ii) U.S. federal, state and local tax planning, advice and assistance
regarding statutory, regulatory or administrative developments.
ALL OTHER FEES
(d) The aggregate fees billed from the Registrant's inception on June 29,
2006 through December 31, 2006 for products and services provided by
the principal accountant, other than the services reported in
paragraphs (a) through (c) of this Item was $0.
(e)(1) Disclose the audit committee's pre-approval policies and procedures
described in paragraph (c)(7) of Rule 2-01 of Regulation S-X.
The Audit Committee shall:
(a) have direct responsibility for the appointment, compensation,
retention and oversight of the Fund's independent auditors and, in
connection therewith, to review and evaluate matters potentially
affecting the independence and capabilities of the auditors; and
(b) review and pre-approve (including associated fees) all audit and
other services to be provided by the independent auditors to the
Fund and all non-audit services to be provided by the independent
auditors to the Fund's investment adviser or any entity
controlling, controlled by or under common control with the
investment adviser (an "Adviser Affiliate") that provides ongoing
services to the Fund, if the engagement relates directly to the
operations and financial reporting of the Fund; and
(c) establish, to the extent permitted by law and deemed appropriate
by the Audit Committee, detailed pre-approval policies and
procedures for such services; and
(d) consider whether the independent auditors' provision of any
non-audit services to the Fund, the Fund's investment adviser or
an Adviser Affiliate not pre-approved by the Audit Committee are
compatible with maintaining the independence of the independent
auditors.
(e)(2) The percentage of services described in each of paragraphs (b) through
(d) of this Item that were approved by the audit committee pursuant to
paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X are as follows:
(b) 100%
(c) 100%
(d) N/A
(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most
recent fiscal year that were attributed to work performed by persons
other than the principal accountant's full-time, permanent employees
was less than fifty percent.
(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's
investment adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or overseen by
another investment adviser), and any entity controlling, controlled by,
or under common control with the adviser that provides ongoing services
to the registrant for each of the last two fiscal years of the
registrant was $200,000.
(h) The registrant's audit committee of the board of directors has
considered whether the provision of non-audit services that were
rendered to the registrant's investment adviser (not including any
sub-adviser whose role is primarily portfolio management and is
subcontracted with or overseen by another investment adviser), and any
entity controlling, controlled by, or under common control with the
investment adviser that provides ongoing services to the registrant
that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X is compatible with maintaining the principal
accountant's independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
The Registrant has a separately-designated standing audit committee established
in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934,
as amended. It is composed of the following Directors, each of who is not an
"interested person" as defined in the 1940 Act:
Timothy K. Hui
Scott F. Kavanaugh
James F. Leary
Bryan A. Ward
ITEM 6. SCHEDULE OF INVESTMENTS.
Schedule of Investments in securities of unaffiliated issuers as of the close of
the reporting period is included as part of the report to shareholders filed
under Item 1 of this form.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Proxy Voting Policies are attached herewith.
Highland Capital Management, L.P. (the "Adviser") has adopted proxy voting
guidelines (the "Guidelines") that provide as follows:
o The Adviser votes proxies in respect of a client's securities in the
client's best economic interests and without regard to the interests of
the Adviser or any other client of the Adviser.
o Unless the Adviser otherwise determines (and documents the basis for
its decision) or as otherwise provided below, the Adviser votes proxies
in a manner consistent with the Guidelines.
o To avoid material conflicts of interest, the Adviser applies the
Guidelines in an objective and consistent manner across client
accounts. Where a material conflict of interest has been identified and
the matter is covered by the Guidelines, the Adviser votes in
accordance with the Guidelines. For clients that are registered
investment companies, where a conflict of interest has been identified
and the matter is not covered in the Guidelines, the Adviser will
disclose the conflict and the determination of the manner in which to
vote to the Fund's Board. For clients that are not investment
companies, where a conflict of interest has been identified and the
matter is not covered in the Guidelines, the Adviser will disclose the
conflict to the client and advise the client that its securities will
be voted only upon the client's written direction.
o The Adviser also may determine not to vote proxies in respect of
securities of any issuer if it determines it would be in its clients'
overall best interests not to vote.
The Adviser's Guidelines address how it will vote proxies on particular types of
matters such as changes in corporate government structures, adoption of options
plans and anti-takeover proposals. For example, the Adviser generally will:
o support management in most elections for directors, unless the board
gives evidence of acting contrary to the best economic interests of
shareholders;
o support option plans, if it believes that they provide for their
administration by disinterested parties and provide incentive to
directors, managers and other employees by aligning their economic
interests with those of the shareholders while limiting the transfer of
wealth out of the company; and
o oppose anti-takeover proposals unless they are structured in such a way
that they give shareholders the ultimate decision on any proposal or
offer.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
(A)(1) IDENTIFICATION OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS AND
DESCRIPTION OF ROLE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS
The Fund's portfolio is managed by a portfolio management team. As of
the date of this filing, the members of the team who are primarily responsible
for the day-to-day management of the Fund's portfolio are Kurtis S. Plumer,
James Dondero, Mark Okada and Patrick H. Daugherty.
KURTIS S. PLUMER, CFA - Mr. Plumer is a Partner and Senior Portfolio
Manager at Highland Capital Management, L.P. ("Highland"), covering the Energy
and Food sectors. Prior to joining Highland in July 1999, Mr. Plumer was a
distressed high yield bond trader at Lehman Brothers in New York, where he
managed a $250
million portfolio invested in global distressed securities. While at Lehman, he
also traded emerging market sovereign bonds. Prior to joining Lehman Brothers,
Mr. Plumer was a corporate finance banker at NationsBanc Capital Markets, Inc.
(now Bank of America Capital Markets, Inc.) where he focused on M&A and
financing transactions for the bank's clients. Mr. Plumer has over 14 years of
experience in distressed, high yield bond and leveraged loan products. Mr.
Plumer earned a BBA in Economics and Finance from Baylor University and an MBA
in Strategy and Finance from the Kellogg School at Northwestern University. Mr.
Plumer has earned the right to use the Chartered Financial Analyst designation.
JAMES DONDERO, CA, CPA, CMA - Mr. Dondero is a founder and President of
Highland Capital Management, L.P. ("Highland")and has served as President Mr.
Dondero is a founder and President of Highland and has served as President since
1993. Mr. Dondero is also President of the funds in the Highland Fund Complex.
Formerly, Mr. Dondero served as Chief Investment Officer of Protective Life's
GIC subsidiary and helped grow the business from concept to over $2 billion
between 1989 and 1993. His portfolio management experience includes investments
in mortgage-backed securities, investment grade corporate bonds, leveraged bank
loans, emerging markets, derivatives, preferred stocks and common stocks. From
1985 to 1989, he managed approximately $1 billion in fixed income funds for
American Express. Prior to American Express, he completed his financial training
at Morgan Guaranty Trust Company. Mr. Dondero is a Beta Gamma Sigma graduate of
the University of Virginia, 1984 with degrees in Accounting and Finance. Mr.
Dondero is a Certified Public Accountant, Chartered Financial Analyst and a
Certified Management Accountant
MARK OKADA, CFA - Mr. Okada is a Founder and Chief Investment Officer
at Highland Capital Management, L.P. ("Highland"). He is responsible for
overseeing Highland's investment activities for its various funds and has over
19 years of experience in the leveraged finance market. Before joining the
Highland, Mr. Okada served as Manager of Fixed Income for Protective Life's GIC
subsidiary from 1990 to 1993. He was primarily responsible for the bank loan
portfolio and other risk assets. Protective was one of the first non-bank
entrants into the syndicated loan market. From 1986 to 1990, he served as Vice
President for Hibernia National Bank, managing over U.S.$1 billion of high yield
bank loans. Mr. Okada is an honours graduate of the University of California Los
Angeles with degrees in Economics and Psychology. He completed his credit
training at Mitsui and has earned the right to use the Chartered Financial
Analyst designation. Mr. Okada is also Chairman of the Board of Directors of
Common Grace Ministries Inc.
PATRICK H. DAUGHERTY - Mr. Daugherty is a Partner at Highland and is
Head of Special Situations Investments. His responsibilities include managing
the Distressed Investments Group and co-managing the Private Equity Investments
Group. He has formerly served as General Counsel to Highland. Prior to joining
Highland in April 1998, Mr. Daugherty served as Vice President in the Corporate
Finance Group at Bank of America Capital Markets, Inc (formerly NationsBanc
Capital Markets, Inc.) where he originated and structured leveraged transactions
of mid-cap companies located in the Southwest. Prior to joining Bank of America,
Mr. Daugherty was an Associate with the law firm of Baker, Brown, Sharman and
Parker in Houston, Texas where he worked with banks and financial institutions
in the liquidation of various RTC portfolios. Mr. Daugherty has over 15 years of
experience in distressed, high yield and corporate restructuring. He has been
involved in over 100 restructurings and held steering committee positions in
over 40 bankruptcies. Mr. Daugherty currently serves on the Board of Directors
of Trussway Holdings, Inc. and its affiliates (as Chairman), Home Interiors &
Gifts, Inc. and its affiliates (as Chairman), Nexpak Corporation and its
affiliates (as Chairman), Moll Industries and its affiliates (as Chairman), and
is a former board member of Norse Merchant Group and its affiliates, Ferrimorac
Holdings Limited and Mariner Health Care, Inc. He received a BBA in Finance from
The University of Texas at Austin and a Juris Doctorate from The University of
Houston School of Law. Mr. Daugherty's professional certifications include
membership in the Texas Bar Association and admittance to the American Bar
Association in 1992.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBER
AND POTENTIAL CONFLICTS OF INTEREST
OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBER
The following tables provide information about funds and accounts,
other than the Fund, for which the Fund's portfolio managers are primarily
responsible for the day-to-day portfolio management as of December 31, 2006.
KURTIS S. PLUMER
-------------------------------------------------------------------------------------------------------------
Total # of Accounts Managed Total Assets with
# of Accounts Total Assets with Performance-Based Performance-Based
Type of Accounts Managed (millions) Advisory Fee Advisory Fee (millions)
-------------------------------------------------------------------------------------------------------------
Registered Investment 2 $1,079 1 $76
Companies:
-------------------------------------------------------------------------------------------------------------
Other Pooled Investment 5 $1,618 3 $1,068
Vehicles:
-------------------------------------------------------------------------------------------------------------
Other Accounts: 0 $0 0 $0
-------------------------------------------------------------------------------------------------------------
JAMES DONDERO
-------------------------------------------------------------------------------------------------------------
Type of Accounts Total Total Assets # of Accounts Managed Total Assets with
# of Accounts with Performance-Based Performance-Based
Managed (millions) Advisory Fee Advisory Fee (millions)
-------------------------------------------------------------------------------------------------------------
Registered Investment 3 $1,084 1 $76
Companies:
-------------------------------------------------------------------------------------------------------------
Other Pooled Investment 10 $4,095 9 $4,045
Vehicles:
-------------------------------------------------------------------------------------------------------------
Other Accounts: 0 $0 0 $0
-------------------------------------------------------------------------------------------------------------
MARK OKADA
--------------------------------------------------------------------------------------------------------------
Type of Accounts Total Total Assets # of Accounts Managed Total Assets with
# of Accounts with Performance-Based Performance-Based
Managed (millions) Advisory Fee Advisory Fee (millions)
--------------------------------------------------------------------------------------------------------------
Registered Investment 11 $7,714 0 $0
Companies:
--------------------------------------------------------------------------------------------------------------
Other Pooled Investment 28 $16,580 22 $14,814
Vehicles:
--------------------------------------------------------------------------------------------------------------
Other Accounts: 0 $0 0 $0
--------------------------------------------------------------------------------------------------------------
PATRICK H. DAUGHERTY
---------------------------------------------------------------------------------------------------------------
Type of Accounts Total Total Assets # of Accounts Managed Total Assets with
# of Accounts with Performance-Based Performance-Based
Managed (millions) Advisory Fee Advisory Fee (millions)
---------------------------------------------------------------------------------------------------------------
Registered Investment 2 $1,079 1 $76
Companies:
---------------------------------------------------------------------------------------------------------------
Other Pooled Investment 4 $3,011 2 $2,461
Vehicles:
---------------------------------------------------------------------------------------------------------------
Other Accounts: 0 $0 0 $0
---------------------------------------------------------------------------------------------------------------
POTENTIAL CONFLICTS OF INTERESTS
The Adviser has built a professional working environment, a firm-wide
compliance culture and compliance procedures and systems designed to protect
against potential incentives that may favor one account over another. Highland
has adopted policies and procedures that address the allocation of investment
opportunities, execution of portfolio transactions, personal trading by
employees and other potential conflicts of interest that are designed to ensure
that all client accounts are treated equitably over time. Nevertheless, the
Adviser furnishes advisory services to numerous clients in addition to the Fund,
and the Adviser may, consistent with applicable law, make investment
recommendations to other clients or accounts (including accounts that are hedge
funds or have performance or higher fees paid to the Adviser or in which
portfolio managers have a personal interest in the receipt of such fees) that
may be the same as or different from those made to the Fund. In addition, the
Adviser, its affiliates and any of their partners, directors, officers,
stockholders or employees may or may not have an interest in the securities
whose purchase and sale the Adviser recommends to the Fund. Actions with respect
to securities of the same kind may be the same as or different from the action
that the Adviser, or any of its affiliates, or any of their partners, directors,
officers, stockholders or employees or any member of their families may take
with respect to the same securities. Moreover, the Adviser may refrain from
rendering any advice or services concerning securities of companies of which any
of the Adviser's (or its affiliates') partners, directors, officers or employees
are directors or officers, or companies as to which the Adviser or any of its
affiliates or the partners, directors, officers and employees of any of them has
any substantial economic interest or possesses material non-public information.
In addition to its various policies and procedures designed to address these
issues, the Adviser includes disclosure regarding these matters to its clients
in both its Form ADV and investment advisory agreements.
The Adviser, its affiliates or their partners, directors, officers and
employees similarly serve or may similarly serve other entities that operate in
the same or related lines of business. Accordingly, these individuals may have
obligations to investors in those entities or funds or to other clients, the
fulfillment of which might not be in the best interests of the Fund. As a
result, the Adviser will face conflicts in the allocation of investment
opportunities to the Fund and other funds and clients. In order to enable such
affiliates to fulfill their fiduciary duties to each of the clients for which
they have responsibility, the Adviser will endeavor to allocate investment
opportunities in a fair and equitable manner which may, subject to applicable
regulatory constraints, involve pro rata co-investment by the Fund and such
other clients or may involve a rotation of opportunities among the Fund and such
other clients.
While the Adviser does not believe there will be frequent conflicts of
interest, if any, the Adviser and its affiliates have both subjective and
objective procedures and policies in place designed to manage the potential
conflicts of interest between the Adviser's fiduciary obligations to the Fund
and their similar fiduciary obligations to other clients so that, for example,
investment opportunities are allocated in a fair and equitable manner among the
Fund and such other clients. An investment opportunity that is suitable for
multiple clients of the Adviser and its affiliates may not be capable of being
shared among some or all of such clients due to the limited scale of the
opportunity or other factors, including regulatory restrictions imposed by the
1940 Act. There can be no assurance that the Adviser's or its affiliates'
efforts to allocate any particular investment opportunity fairly among all
clients for whom such opportunity is appropriate will result in an allocation of
all or part of such opportunity to the Fund. Not all conflicts of interest can
be expected to be resolved in favor of the Fund.
The Adviser expects to apply to the SEC for exemptive relief to enable
the Fund and registered investment companies advised by the Adviser to co-invest
with other accounts and funds managed by the Adviser and its affiliates in
certain privately-placed securities and other situations. There are no
assurances that the Adviser will receive the requested relief. If such relief is
not obtained and until it is obtained, the Adviser may be required to allocate
some investments solely to any of the Fund, a registered fund, or another
account or fund advised by the Adviser or its affiliates. This restriction could
preclude the Fund from investing in certain securities it would otherwise be
interested in and could adversely affect the speed at which the Fund is able to
invest its assets and, consequently, the performance of the Fund.
(A)(3) COMPENSATION STRUCTURE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS
Highland's financial arrangements with its portfolio managers, its
competitive compensation and its career path emphasis at all levels reflect the
value senior management places on key resources. Compensation may include a
variety of components and may vary from year to year based on a number of
factors including the relative performance of a portfolio managers underlying
account, the combined performance of the portfolio managers underlying accounts,
and the relative performance of the portfolio managers underlying accounts
measured against other employees. The principal components of compensation
include a base salary, a discretionary bonus, various retirement benefits and
one or more of the incentive compensation programs established by Highland such
as the Option It Plan and the Long-Term Incentive Plan.
BASE COMPENSATION. Generally, portfolio managers receive base
compensation based on their seniority and/or their position with the firm, which
may include the amount of assets supervised and other management roles within
the firm.
DISCRETIONARY COMPENSATION. In addition to base compensation, portfolio
managers may receive discretionary compensation, which can be a substantial
portion of total compensation. Discretionary compensation can include a
discretionary cash bonus as well as one or more of the following:
OPTION IT PLAN. The purpose of the Plan is to attract and
retain the highest quality employees for positions of
substantial responsibility, and to provide additional
incentives to a select group of management or highly
compensated employees of the Fund so as to promote the success
of the Fund.
LONG TERM INCENTIVE PLAN. The purpose of the Plan is to create
positive morale and teamwork, to attract and retain key
talent, and to encourage the achievement of common goals. The
Plan seeks to reward participating employees based on the
increased value of Highland through the use of Long-term
Incentive Units.
Senior portfolio managers who perform additional management functions
may receive additional compensation in these other capacities.
Compensation is structured such that key professionals benefit from
remaining with the firm.
(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
The following table sets forth the dollar range of equity securities
beneficially owned by each portfolio manager in the Fund as of December 31,
2006.
NAME OF PORTFOLIO MANAGER DOLLAR RANGES OF EQUITY SECURITIES BENEFICIALLY OWNED BY
PORTFOLIO MANAGER
---------------------------------------------------------------------------------------------------------
Kurtis S. Plumer, None
---------------------------------------------------------------------------------------------------------
James Dondero Over $1,000,000
---------------------------------------------------------------------------------------------------------
Mark Okada None
---------------------------------------------------------------------------------------------------------
Patrick H. Daugherty None
---------------------------------------------------------------------------------------------------------
(B) Not applicable.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
REGISTRANT PURCHASES OF EQUITY SECURITIES
------------------------------------------------------------------------------------------------------------
(C) TOTAL NUMBER OF (D) MAXIMUM NUMBER (OR
(A) TOTAL NUMBER (B) AVERAGE SHARES (OR UNITS) APPROXIMATE DOLLAR VALUE) OF
OF SHARES PRICE PAID PURCHASED AS PART OF SHARES (OR UNITS) THAT MAY
(OR UNITS) PER SHARE PUBLICLY ANNOUNCED YET BE PURCHASED UNDER THE
PERIOD PURCHASED (OR UNIT) PLANS OR PROGRAMS PLANS OR PROGRAMS
------------------------------------------------------------------------------------------------------------
July 1, 2006 to - - - 34,511,356.00
July 31, 2006
------------------------------------------------------------------------------------------------------------
August 1, 2006 - - - 34,511,356.00
to August 31,
2006
------------------------------------------------------------------------------------------------------------
September 1, 1,505.332 $19.27 1,505.332 34,511,356.00
2006 to
September 30,
2006
------------------------------------------------------------------------------------------------------------
October 1, 2006 1,890.975 $19.50 1,890.975 34,511,356.00
to October 31,
2006
------------------------------------------------------------------------------------------------------------
November 1, 1,157.746 $19.88 1,157.746 34,511,356.00
2006 to
November 30,
2006
------------------------------------------------------------------------------------------------------------
December 1, 1,564.6468 $20.10 1,564.6468 34,511,356.00
2006 to
December 31,
2006
------------------------------------------------------------------------------------------------------------
Total 6,118.6998 $19.69 6,118.6998 34,511,356.00
------------------------------------------------------------------------------------------------------------
Note: all purchases were made in the open market.
a. The date each plan or program was announced: Purchases were made
pursuant to an Automatic Dividend Reinvestment Plan that was last filed
with the SEC on June 21, 2006.
b. The dollar amount (or share or unit amount) approved : NONE
c. The expiration date (if any) of each plan or program: NONE
d. Each plan or program that has expired during the period covered by the
table: NONE
e. Each plan or program the registrant has determined to terminate prior
to expiration, or under which the registrant does not intend to make
further purchases.: NONE
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these controls
and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR
270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities
Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17
CFR 270.30a-3(d)) that occurred during the registrant's second fiscal
quarter of the period covered by this report that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of ethics subject to disclosure required by Item 2 is
attached hereto.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act
and Section 302 of the Sarbanes-Oxley Act of 2002 are
attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act
and Section 906 of the Sarbanes-Oxley Act of 2002 are
attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) HIGHLAND CREDIT STRATEGIES FUND
By (Signature and Title)* /S/ JAMES D. DONDERO
-------------------------------------------------------
James D. Dondero, Chief Executive Officer
(principal executive officer)
Date MARCH 5, 2007
----------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /S/ JAMES D. DONDERO
-------------------------------------------------------
James D. Dondero, Chief Executive Officer
(principal executive officer)
Date MARCH 5, 2007
----------------------------------------------------------------------------
By (Signature and Title)* /S/ M. JASON BLACKBURN
-------------------------------------------------------
M. Jason Blackburn, Chief Financial Officer
(principal financial officer)
Date MARCH 5, 2007
----------------------------------------------------------------------------
* Print the name and title of each signing officer under his or her signature.