There is no assurance that the trends described in this report will continue or commence.
Privacy Policy
We recognize and respect your privacy expectations, whether you are a visitor to our web site, a potential shareholder, a current shareholder or even a
former shareholder.
Collection of Information. We may collect nonpublic personal information about you from the following sources:
Account applications and other forms, which may include your name, address and social security number, written and electronic correspondence and telephone contacts;
Web site information, including any information captured through the use of cookies; and
Account history, including information about the transactions and balances in your accounts with us or our affiliates.
Disclosure of Information. We may share the information we collect with our affiliates. We may also disclose this information as otherwise
permitted by law. We do not sell your personal information to third parties for their independent use.
Confidentiality and Security of
Information. We restrict access to nonpublic personal information about you to our employees and agents who need to know such information to provide products or services to you. We maintain physical, electronic and procedural safeguards that
comply with federal standards to guard your nonpublic personal information, although you should be aware that data protection cannot be guaranteed.
The NexPoint Credit Strategies Fund (the Fund) seeks to provide both current income and capital appreciation.
Total Net Assets of Common Shares as of June 30, 2014
$876.0 million
Portfolio Data as of June 30, 2014
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.
Fortinet, Inc. (Common Stocks & Exchange-Traded Funds)
4.3
NRG Energy, Inc. (Common Stocks & Exchange-Traded Funds)
4.2
Comcorp Broadcasting, Inc. (U.S. Senior Loans)
4.1
K12, Inc. (Common Stocks & Exchange-Traded Funds)
4.1
Staples, Inc. (Common Stocks & Exchange-Traded Funds)
4.0
Argentine Republic Government International Bond (Sovereign Bonds)
3.5
(1)
Quality is calculated as a percentage of total senior loans, asset-backed securities and corporate bonds & notes. Sectors and holdings are calculated as a percentage of total net assets. The quality ratings
reflected were issued by Standard & Poors, a nationally recognized statistical rating organization. Ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest). Quality ratings reflect the credit quality of the
underlying bonds in the Funds portfolio and not that of the Fund itself. Quality Ratings are subject to change.
(2)
Excludes the Funds investment in an investment company purchased with cash collateral from securities lending.
A guide to understanding the Funds financial statements
Investment Portfolio
The Investment Portfolio details all of the Funds holdings and their 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 Funds 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 Funds liabilities (including any unpaid
expenses) from the total of the Funds 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 Funds net increase or decrease in net assets from operations applicable to common shareholders.
Statements of Changes in Net Assets
These statements detail how the Funds net assets were affected by its operating results, distributions to common shareholders and shareholder transactions from common shares (e.g., subscriptions, redemptions and distribution
reinvestments) during the reporting period. The Statements of Changes in Net Assets also detail 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 Funds net asset value per common share was affected by the Funds operating results. The Financial Highlights also disclose the Funds 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.
Senior loans (also called bank loans, leveraged loans, or floating rate loans) in which the Fund invests generally pay interest at rates which are periodically determined by reference to a base lending rate plus a
spread (unless otherwise identified, all senior loans carry a variable rate of interest). These base lending rates are generally (i) the Prime Rate offered by one or more major United States banks, (ii) the lending rate offered by one or
more European banks such as the London Interbank Offered Rate (LIBOR) or (iii) the Certificate of Deposit rate. Rate shown represents the weighted average rate at June 30, 2014. Senior loans, while exempt from registration
under the Securities Act of 1933 (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 maturity shown.
(b)
Represents fair value as determined by the Funds Board of Trustees (the Board), or its designee in good faith, pursuant to the policies and procedures approved by the Board. Securities with a total
aggregate value of $183,368,064, or 20.9% of net assets, were fair valued under the Funds valuation procedures as of June 30, 2014.
(c)
All or a portion of this position has not settled. Full contract rates do not take effect until settlement date.
(d)
The issuer is, or is in danger of being, in default of its payment obligation. Income is not being accrued.
(e)
Fixed rate senior loan.
(f)
Securities exempt from registration under Rule 144A of the 1933 Act. These securities may only be resold in transaction exempt from registration to qualified institutional buyers. At June 30, 2014, these securities
amounted to $335,311,299 or 38.3% of net assets.
(g)
Variable or floating rate security. The interest rate shown reflects the rate in effect June 30, 2014.
(h)
All or part of the security is pledged as collateral for the Committed Facility Agreement with BNP Paribas Prime Brokerage, Inc. The market value of the securities pledged as collateral was $270,305,872.
(i)
Step coupon bond. The interest rate shown reflects the rate in effect June 30, 2014 and will reset at a future date.
(j)
Affiliated issuer. Assets with a total aggregate market value of $221,845,628, or 25.3% of net assets, were affiliated with the Fund as of June 30, 2014.
(k)
All or part of this security is pledged as collateral for short sales. The market value of the securities pledged as collateral was $254,219,583.
(l)
Non-income producing security.
(m)
Restricted Securities. These securities are not registered and may not be sold to the public. There are legal and/or contractual restrictions on resale. The Fund does not have the right to demand that such securities be
registered. The values of these securities are determined by valuations provided by pricing services, brokers, dealers, market makers, or in good faith under the procedures established by the Funds Board of Trustees.
(n)
Represents investments of cash collateral received in connection with securities lending.
(o)
Cost for U.S. federal income tax purposes is $1,360,609,122.
(p)
No dividend payable on security sold short.
Currency Abbreviations:
EUR
Euro Currency
GBP
British Pound
Glossary:
ADR
American Depositary Receipt
CDO
Collateralized Debt Obligation
CLO
Collateralized Loan Obligation
ETF
Exchange-Traded Fund
PIK
Payment-in-Kind
PLC
Public Limited Company
PNC
PNC Capital Markets LLC
REIT
Real Estate Investment Trust
Forward foreign currency exchange contracts outstanding as of June 30, 2014 were as follows:
Contracts to Buy or to Sell
Currency
Counterparty
Principal Amount Covered by Contracts
Expiration
Unrealized Appreciation/ (Depreciation)
Sell
EUR
PNC
2,520,000
07/31/2014
$
(10,331
)
Foreign Denominated or Domiciled Senior Loans and Foreign Corporate Bonds & Notes Industry Concentration Table: (% of Net
Assets)
Unaffiliated issuers, at value (cost $1,131,238,993)
1,131,702,687
Affiliated issuers, at value (cost $224,740,959) (Note 11)
221,845,628
Total investments, at value (cost $1,355,979,952)
1,353,548,315
Cash
51,241,908
Receivable for:
Investments sold
13,960,095
Dividends & interest receivable
6,476,132
Other assets
137,434
Total assets
1,425,363,884
Liabilities:
Notes payable (Notes 6)
400,000,000
Securities sold short, at value (proceeds $61,852,512) (Notes 2 and 9)
74,393,384
Net unrealized depreciation on forward foreign currency exchange contracts
10,331
Payable upon receipt of securities loaned (Note 4)
1,009,913
Restricted Cash Securities sold short (Note 2)
4,094,069
Payable for:
Investments purchased
67,720,354
Investment advisory fee payable (Note 8)
1,012,241
Administration fee (Note 8)
202,448
Audit and tax payable
80,873
Trustees fees (Note 8)
22,708
Interest payable (Note 6)
336,980
Accrued expenses and other liabilities
510,029
Total Liabilities
549,393,330
Net Assets Applicable To Common Shares
875,970,554
Composition of Net Assets:
Par value of common shares (Note 1)
63,881
Paid-in capital in excess of par value of common shares
1,139,462,715
Undistributed net investment income
13,903,128
Accumulated net realized loss from investments, securities sold short and foreign currency transactions
(262,177,203
)
Net unrealized depreciation on investments, securities sold short, forward foreign currency exchange contracts and translation of assets and
liabilities denominated in foreign currency
(15,281,967
)
Net Assets Applicable to Common Shares
875,970,554
Common Shares
Net assets
875,970,554
Shares outstanding (unlimited authorization)
63,881,473
Net asset value per share (Net assets/shares outstanding)
Net realized gain on investments, securities sold short, written options, forward foreign currency exchange contracts and foreign currency
transactions
123,689,684
78,104,379
Net change in unrealized appreciation/(depreciation) on investments, securities sold short, written options, forward foreign currency exchange
contracts and translation of assets and liabilities denominated in foreign currency
20,307,237
165,632,087
Net change in net assets from operations
172,885,851
283,292,539
Distributions Declared to Common Shareholders
From net investment income
(21,400,293
)
(35,070,929
)
Total distributions declared to common shareholders
(21,400,293
)
(35,070,929
)
Total increase in net assets from common shares
151,485,558
248,221,610
Net Assets Applicable to Common Shares
Beginning of period
724,484,996
476,263,386
End of period (including undistributed net investment income of $13,903,128 and $6,414,491, respectively)
Selected data for a share outstanding throughout each period is as follows:
For the Six Months Ended June 30, 2014 (unaudited)
For the Years Ended December 31,
Common Shares Per Share Operating Performance:
2013
2012
2011
2010
2009
Net Asset Value, Beginning of Period
$
11.34
$
7.46
$
6.94
$
7.72
$
7.20
$
6.51
Income from Investment Operations:
Net investment income
0.46
0.63
0.43
0.47
0.59
0.74
Net realized and unrealized gain/(loss)
2.25
3.80
0.52
(0.72
)
0.56
0.74
Total from investment operations
2.71
4.43
0.95
(0.25
)
1.15
1.48
Less Distributions Declared to Common Shareholders:
From net investment income
(0.34
)
(0.55
)
(0.43
)
(0.53
)
(0.63
)
(0.79
)
Total distributions declared to common shareholders
(0.34
)
(0.55
)
(0.43
)
(0.53
)
(0.63
)
(0.79
)
Net Asset Value, End of Period
$
13.71
$
11.34
$
7.46
$
6.94
$
7.72
$
7.20
Market Value, End of Period
$
12.07
$
9.42
$
6.64
$
6.18
$
7.58
$
6.31
Market Value Total Return(a)
31.92
%(b)
52.03
%
14.73
%
(12.18
)%
30.76
%
27.69
%
Ratios and Supplemental Data:
Net assets, end of period (in 000s)
$
875,971
$
724,485
$
476,263
$
443,048
$
492,753
$
458,764
Common Share Information at End of Period:
Ratios based on average net assets of common shares:
Gross operating expenses (excluding interest expense and commitment fee)(c)
2.08
%(d)
2.22
%
2.22
%
2.23
%
2.13
%
2.41
%
Interest expense and commitment fee
0.47
%(d)
0.60
%
0.92
%
0.92
%
1.01
%
1.49
%
Fees and expenses waived
NA
NA
NA
NA
(0.14
)%
(0.31
)%
Net operating expenses (including interest expense and commitment fee)(c)
2.55
%(d)
2.82
%
3.14
%
3.15
%
3.00
%
3.59
%
Net investment income
7.30
%(d)
7.01
%
6.00
%
6.24
%
7.92
%
11.09
%
Ratios based on managed net assets of common shares:
Gross operating expenses (excluding interest and commitment fee expense)(c)
1.43
%(d)
1.56
%
1.60
%
1.61
%
1.70
%
1.93
%
Interest expense and commitment fee
0.32
%(d)
0.42
%
0.66
%
0.66
%
0.81
%
1.19
%
Fees and expenses waived
N/A
N/A
N/A
N/A
(0.11
)%
(0.25
)%
Net operating expenses (including interest expense and commitment fee)(c)
1.75
%(d)
1.98
%
2.26
%
2.27
%
2.40
%
2.87
%
Net investment income
5.01
%(d)
4.91
%
4.32
%
4.50
%
6.34
%
8.88
%
Portfolio turnover rate
29
%(b)
74
%
92
%
52
%
91
%
88
%
(a)
Based on market value per share. Distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under the Funds Dividend Reinvestment Plan.
(b)
Not annualized
(c)
Includes dividends and expenses on securities sold short.
NexPoint
Credit Strategies Fund (the Fund) is a Delaware statutory trust and is registered with the Securities and Exchange Commission (the SEC) under the Investment Company Act of 1940, as amended (the 1940 Act), as a
non-diversified, closed-end management investment company. The financial statements include information for the period ended June 30, 2014. The Fund trades on the New York Stock Exchange (NYSE) under the ticker symbol NHF. The Fund
may issue an unlimited number of common shares, par value $0.001 per share (Common Shares). The Fund commenced operations on June 29, 2006. NexPoint Advisors, L.P. (NexPoint) or Investment Advisor, an
affiliate of Highland Capital Management Fund Advisors, L.P. (Highland), is the investment advisor and administrator to the Fund.
Note 2.
Significant Accounting Policies
The following summarizes the significant accounting policies consistently followed by the Fund in the preparation of its
financial statements.
Use of Estimates
The Funds financial
statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP), which require 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. Changes in the economic environment, financial markets and any
other parameters used in determining these estimates could cause actual results to differ materially.
Fund Valuation
The net asset value (NAV) of the Funds common shares is calculated daily on each day that the NYSE is open for business as of the close of the regular
trading session on the NYSE, usually 4:00 PM, Eastern time. The NAV is calculated by dividing the value of the Funds net assets attributable to common shares by the numbers of common shares outstanding.
Valuation of Investments
In computing the Funds net assets
attributable to common shares, securities with readily available market quotations on the NYSE, NASDAQ or other nationally recognized exchange, use the closing quotations on the respective exchange for valuation of those securities. Securities for
which there are no readily available market quotations will be valued pursuant to policies adopted by the Board of Trustees. Typically, such securities will be valued at the
mean between the most recently quoted bid and ask 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 may be priced by an independent pricing service. Generally, the Funds loan and bond positions are not traded on exchanges and consequently
are valued based on a mean of the bid and ask price from the third-party pricing services or broker-dealer sources determined to generally have the capability to provide appropriate pricing services and have been approved by the Trustees.
Securities for which market quotations are not readily available, for which the Fund has determined the price received from a pricing service or broker-dealer is
stale or otherwise does not represent fair value (such as when events materially affecting the value of securities occur between the time when market price is determined and calculation of the Funds NAV), will be valued by the Fund
at fair value, as determined by the Board or its designee in good faith in accordance with procedures approved by the Board, taking into account factors reasonably determined to be relevant, including, among other things,: (i) the fundamental
analytical data relating to the investment; (ii) the nature and duration of restrictions on disposition of the securities; and (iii) an evaluation of the forces that influence the market in which these securities are purchased and sold. In
these cases, the Funds NAV will reflect the affected portfolio securities fair value as determined in the judgment of the Board 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 securitys most recent sale price and from the prices used by other investment companies to calculate their NAV. Determination of fair value is uncertain because it involves subjective
judgments and estimates.
There can be no assurance that the Funds valuation of a security will not differ from the amount that it realizes upon the sale of
such security. Those differences could have a material impact to the Fund.
Fair Value Measurements
The Fund has performed an analysis of all existing investments and derivative instruments to determine the significance and character of all inputs to their fair value
determination. The levels of fair value inputs used to measure the Funds investments are characterized into a fair value hierarchy. Where inputs for an asset or liability fall into more than one level in the fair value hierarchy, the
investment is classified in its entirety based on the lowest
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
level input that is significant to that investments valuation. The three levels of the fair value hierarchy are described below:
Level 1
Quoted unadjusted prices for identical instruments in active markets to which the Fund has access at the date of measurement;
Level 2
Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active, but are valued based on executed trades; broker quotations that constitute an
executable price; and alternative pricing sources supported by observable inputs are classified within Level 2. Level 2 inputs are either directly or indirectly observable for the asset in connection with market data at the measurement date; and
Level 3
Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. In certain cases, investments classified within Level 3 may include securities for which the Fund has
obtained indicative quotes from broker-dealers that do not necessarily represent prices the broker may be willing to trade on, as such quotes can be subject to material management judgment. Unobservable inputs are those inputs that reflect the
Funds own assumptions that market participants would use to price the asset or liability based on the best available information.
The Investment
Adviser has established policies, as described above and approved by the Board, to ensure that valuation methodologies for investments and financial instruments that are categorized within all levels of the fair value hierarchy are fair and
consistent. A Pricing Committee has been established to provide oversight of the valuation policies, processes and procedures, and is comprised of personnel from the Investment Adviser. The Pricing Committee meets monthly to review the proposed
valuations for investments and financial instruments and is responsible for evaluating the overall fairness and consistent application of those policies.
As of
June 30, 2014, the Funds investments consisted of senior loans, asset-backed securities, corporate bonds and notes, common stocks, preferred stocks, exchange-traded funds, warrants, securities sold short, options and forward foreign
currency exchange contracts. The fair value of the Funds loans, bonds and asset-backed securities are generally based on quotes received from brokers or independent pricing services. Loans, bonds and asset-backed securities with quotes that
are based on actual
trades with a sufficient level of activity on or near the measurement date are classified as Level 2 assets. Loans, bonds and asset-backed securities that are priced using quotes derived from
implied values, indicative bids, or a limited number of actual trades are classified as Level 3 assets because the inputs used by the brokers and pricing services to derive the values are not readily observable.
The fair value of the Funds common stocks, preferred stocks, warrants and options that are not actively traded on national exchanges are generally priced using
quotes derived from implied values, indicative bids, or a limited amount of actual trades and are classified as Level 3 assets because the inputs used by the brokers and pricing services to derive the values are not readily observable. Exchange
traded options are valued based on the last trade price on the primary exchange on which they trade. If an option does not trade, the mid-price is utilized to value the option. Forward foreign currency exchange contracts are valued using a
straight-line interpolation based on a series of forward rates. The Funds real estate investments include equity interests in limited liability companies and equity issued by REITs that invest in commercial and residential real estate. The
fair value of real estate investments that are not actively traded on national exchanges are based on internal models developed by the Investment Advisor. The significant inputs to the models include cash flow projections for the underlying
properties and appraisals performed by independent valuation firms. These inputs are not readily observable, and the Fund has classified the investments as Level 3 assets.
At the end of each calendar quarter, management evaluates the Level 2 and 3 assets and liabilities for changes in liquidity, including but not limited to: whether a
broker is willing to execute at the quoted price, the depth and consistency of prices from third party services, and the existence of contemporaneous, observable trades in the market. Additionally, management evaluates the Level 1 and 2 assets and
liabilities on a quarterly basis for changes in listings or delistings on national exchanges.
Due to the inherent uncertainty of determining the fair value of
investments that do not have a readily available market value, the fair value of the Funds investments may fluctuate from period to period. Additionally, the fair value of investments may differ significantly from the values that would have
been used had a ready market existed for such investments and may differ materially from the values the Fund may ultimately realize. Further, such investments may be subject to legal and other restrictions on resale or otherwise less liquid than
publicly traded securities.
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
The
inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. Transfers in and out of the levels are recognized at the value at the end of the period. A summary of the
inputs used to value the Funds assets as of June 30, 2014 is as follows:
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
The
table below sets forth a summary of changes in the Funds Level 3 assets (assets measured at fair value using significant unobservable inputs) for the period ended June 30, 2014.
Balance as of December 31, 2013
Transfers into Level 3
Transfers Out of Level 3
Net Amortization (Accretion) of Premium/ (Discount)
Net Realized Gains/ (Losses)
Net Unrealized Gains/ (Losses)
Net Purchases(1)
Net (Sales)(1)
Balance as of June 30, 2014
Change in Unrealized Gain/(Loss) on Level 3 securities still held at period end
U.S. Senior Loans
$
42,569,445
$
$
$
731,524
$
(9,285,675
)
$
10,374,331
$
8,948,899
$
(607,530
)
$
52,730,994
$
1,121,091
Foreign Denominated or Domiciled
Senior Loans
157,758
61,271
2,618,421
2,837,450
61,271
Asset-Backed Securities
15,561,628
154,998
359,484
157,219
(4,434,447
)
11,798,882
744,627
Corporate Bonds & Notes(2)
1,379,833
(5,340,219
)
5,714,875
(1,754,489
)
Foreign Corporate Bonds & Notes(2)
2,367,703
(1,722,552
)
645,151
Common Stocks
Broadcasting
16,084,928
603,185
16,688,113
603,185
Financial
342,517
(25
)
(90,186
)
14,000,000
(12,749,975
)
1,502,331
(90,186
)
Gaming & Leisure
2,071,552
(766,636
)
1,304,916
2,071,552
Healthcare
13,992,000
8,181,595
(6,127,200
)
(8,181,595
)
7,864,800
(6,127,200
)
Housing
1,126,539
51,541
1,178,080
51,541
Media & Telecommunications
Real Estate
280,310
906,980
(1,187,290
)
280,310
Real Estate Investment Trust
42,964,014
1,119,677
58,371,834
102,455,525
1,119,677
Preferred Stocks
Financial
14,218,831
(2,824,629
)
14,243,750
25,637,952
(2,824,629
)
Warrants
Equity Contracts
Total
$
150,765,196
$
$
$
886,522
$
(6,084,840
)
$
9,669,394
$
99,089,884
$
(29,681,962
)
$
224,644,194
$
(2,988,761
)
(1)
Includes any applicable borrowings and/or paydowns made on revolving credit facilities held in the Funds Investment Portfolio.
(2)
Balance as of December 31, 2013 reflects a sector reclassification for Celtic Pharma Phinco BV from Corporate Bonds & Notes to Foreign Corporate Bonds & Notes.
Investments designated as Level 3 may include assets valued using quotes or indications furnished by brokers which are
based on models or estimates and may not be executable prices. In light of the developing market conditions, the Investment Adviser continues to search for observable data points and evaluate broker quotes and
indications received for portfolio investments. Determination of fair values is uncertain because it involves subjective judgments and estimates that are unobservable.
For the period ended June 30, 2014, there were no transfers between Levels 1, 2 or 3.
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
The
following table summarizes the valuation techniques used and unobservable inputs developed to determine the fair value of material Level 3 investments:
Fund and Category
Ending Balance at 6/30/14
Valuation Technique
Unobservable Inputs
Input Value(s)
NexPoint Credit Strategies Fund
Debt
$
68,012,477
Third-Party Pricing Vendor
N/A
N/A
Multiples Analysis
Liquidity Discount
10%
Liquidation Analysis
Discount Rate
15% - 30%
Liquidity Discount
20%
Preferred Stock
25,637,952
Third-Party Pricing Vendor
N/A
N/A
Common Stocks
28,538,240
Multiples Analysis
Liquidity Discount
20% - 25%
Minority Discount
20% - 40%
Third-Party Pricing Vendor
N/A
N/A
Liquidation Analysis
Liquidity Discount
20%
Recovery Analysis
Scenario Probabilities
Various
Discounted Cash Flows
Scenario Probabilities
Equal Weights
Discount Rate
21%
Real Estate Investment Trust
102,455,525
Fair Valuation - Multiple Scenarios
Capitalization Rates
5% - 9%
Regional Market Appreciation
-12% - 50%
Total
$
224,644,194
The significant unobservable inputs used in the fair value measurement of the Funds debt investments are discount
rates and liquidity discounts. Significant increases or decreases in either of those inputs in isolation would result in a significantly lower or higher fair value measurement.
The significant unobservable inputs used in the fair value measurement of the reporting entitys common stock and preferred stock investments are discount rates,
liquidity discounts, minority discounts and scenario probabilities. Significant changes in either of those inputs in isolation would result in a significantly lower or higher fair value measurement.
The significant unobservable inputs used in the fair value measurement of the reporting entitys real estate investment trust investments are capitalization rates
and regional market appreciation. Significant changes in either of those inputs in isolation would result in a significantly lower or higher fair value measurement.
Security Transactions
Security transactions are accounted for on the trade
date. Realized gains/(losses) on investments sold are recorded on the basis of specific identification method for both financial statement and U.S. federal income tax purposes.
Income Recognition
Corporate actions (including cash dividends) are recorded
on the ex-dividend date, net of applicable withholding taxes, except for certain foreign corporate actions, which
are recorded as soon after ex-dividend date as such information becomes available. Interest income is recorded on the accrual basis.
Accretion of discount and amortization of premium on taxable bonds and loans are computed to the call or maturity date, whichever is shorter, using the effective yield
method. Withholding taxes on foreign dividends have been provided for in accordance with the Funds understanding of the applicable countrys tax rules and rates.
U.S. Federal Income Tax Status
The Fund is treated as a separate taxpayer
for U.S. federal income tax purposes. The Fund intends to qualify each year as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended, and will distribute substantially all of its taxable
income and gains, if any, for the tax year, and as such will not be subject to U.S. 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 U.S. federal excise tax. Therefore, no U.S. federal income or excise tax provisions are recorded.
Management has
analyzed the Funds tax positions taken on U.S. federal income tax returns for all open tax years (current and prior three tax years), and has concluded that no provision for U.S. federal income tax is required in the Funds financial
statements. The Funds U.S. federal and state income and U.S. federal excise tax returns for tax
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
years for which the applicable statutes of limitations have not expired are subject to examination by the Internal Revenue Service and state departments of revenue. Furthermore, management of the
Fund is also not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly change in the next 12 months.
Distributions to Shareholders
The Fund plans to pay distributions from net
investment income monthly and net realized capital gains annually to common shareholders. To permit the Fund to maintain more stable monthly distributions 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 distributions reinvested in
Common Shares of the Fund issued by the Fund or purchased in the open market in accordance with the Funds 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 amount shown in the Statement of Cash Flows is the amount included within the Funds Statement of Assets and Liabilities and includes
cash on hand at its custodian bank and sub-custodian bank, and does not include cash posted as collateral in the segregated account or with the broker-dealers.
Cash & Cash Equivalents
The Fund considers liquid assets deposited
with a bank and certain short-term debt instruments with original maturities of 3 months or less to be cash equivalents. These investments represent amounts held with financial institutions that are readily accessible to pay Fund expenses or
purchase investments. Cash and cash equivalents are valued at cost plus accrued interest, which approximates market value. The value of cash equivalents denominated in foreign currencies is determined by converting to U.S. dollars on the date of the
Statement of Assets and Liabilities.
Foreign Currency
Accounting
records of the Fund are maintained in U.S. dollars. Foreign currencies, investments and other assets and liabilities denominated in foreign currencies 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 securities 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 effects 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.
Securities Sold Short
The Fund may sell securities short. A security sold short is a transaction in which the Fund sells a security it does not own in anticipation that the market price of
that security will decline. When the Fund sells a security short, it must borrow the security sold short from a broker-dealer and deliver it to the buyer upon conclusion of the transaction. The Fund may have to pay a fee to borrow particular
securities and is often obligated to pay over any dividends or other payments received on such borrowed securities. Cash held as collateral for securities sold short is classified as restricted cash on the Statement of Assets and Liabilities.
Securities held as collateral for securities sold short are shown on the Investment Portfolio of the Fund.
When securities are sold short, the Fund intends to limit
exposure to a possible market decline in the value of its portfolio securities through short sales of securities that the Investment Adviser believes possess volatility characteristics similar to those being hedged. In addition, the Fund may use
short sales for non-hedging purposes to pursue its investment objective. Subject to the requirements of the 1940 Act and the Internal Revenue Code of 1986, as amended (the Code), the Fund will not make a short sale if, after giving
effect to such sale, the market value of all securities sold short by the Fund exceeds 25% of the value of its total assets.
Note 3. Derivative Transactions
The Fund is subject to equity price risk, interest rate risk, and foreign currency exchange rate risk in the normal
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
course of pursuing its investment objective. The Fund enters into derivative transactions for the purpose of hedging against the effects of changes in the value of portfolio securities due to
anticipated changes in market conditions, to gain market exposure for residual and accumulating cash positions, and for managing the duration of fixed income investments.
Forward Foreign Currency Exchange Contracts
The Fund enters into forward
foreign currency exchange contracts to facilitate transactions in foreign denominated securities and to manage the Funds currency exposure. Forward foreign currency exchange contracts are valued at the mean between the bid and the offered
forward rates as last quoted by a recognized dealer. The aggregate principal amounts of the contracts are not recorded in the Funds financial statements. Such amounts appear under the caption Forward Foreign Currency Exchange Contracts in the
Investment Portfolio. Fluctuations in the value of the contracts are recorded in the Statement of Assets and Liabilities as an asset (or liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are
closed, when they are recorded as realized gains or losses on foreign currency related transactions. The Funds risks in using these contracts include changes in the value of foreign currency or the possibility that the counterparties do not
perform under the contracts terms. When the Fund enters into a forward foreign currency exchange contract, it is required to segregate cash or liquid securities with its custodian in an amount equal to the value of the Funds total assets
committed to the consummation of the forward contract. If the value of the segregated securities declines, additional cash or securities is segregated so that the value of the account will equal the amount of the Funds commitment with respect
to the contract.
Options
The Fund purchases and writes options, subject
to certain limitations. The Fund may invest in options contracts to manage its exposure to the stock and bond markets and fluctuations in foreign currency values. Writing puts and buying calls tend to increase the Funds exposure to the
underlying instrument while buying puts and writing calls tend to decrease the Funds exposure to the underlying instrument, or economically hedge other Fund investments. The Funds risks in using these contracts include changes in the
value of the underlying instruments, nonperformance of the counterparties under the contracts terms and changes in the liquidity of the secondary market for the contracts. Options are valued at the last sale price, or if no sales occurred on
that day, at the last quoted bid price.
When the Fund writes an option, the amount of the premium received is recorded as a liability and is subsequently adjusted
to the current fair value of the option written. Premiums received from writing options that expire unexercised are treated by the Fund on the expiration date as realized gains from investments. The difference between the premium and the amount paid
on effecting a closing purchase transaction, including brokerage commissions, is also treated as a realized gain, or if the premium is less than the amount paid for the closing purchase, as a realized loss. When an option is exercised, the proceeds
from the sale of the underlying security or the cost basis of the securities purchased are adjusted by the original premium received or paid.
Additional
Derivative Information
The Fund adopted amendments to authoritative guidance on disclosures about derivative instruments and hedging activities which require
that the Fund disclose: a) how and why an entity uses derivative instruments, b) how derivative instruments and related hedged items are accounted for, c) how derivative instruments and related hedged items affect an entitys financial
position, financial performance and cash flows, and d) how the netting of derivatives subject to master netting arrangements affects the net exposure of the fund related to the derivatives.
The fair value of derivative instruments on the Statement of Assets and Liabilities have the following risk exposure at June 30, 2014:
Risk Exposure
Asset Derivative Fair Value
Liability Derivative Fair Value
Equity Price Risk
$
14,827,500
(1)
$
Foreign Exchange Risk
10,331
(2)
(1)
Statement of Assets and Liabilities location: Unaffiliated investments, at value.
(2)
Statement of Assets and Liabilities location: Unrealized depreciation on forward foreign currency exchange contracts.
To
reduce counterparty credit risk with respect to OTC transactions, the Fund has entered into master netting arrangements, established within the Funds International Swap and Derivatives Association, Inc. (ISDA) master agreements,
which allows the Fund to make (or to have an entitlement to receive) a single net payment in the event of default (close-out netting) for outstanding payables and receivables with respect to certain OTC derivative positions in forward currency
exchange contracts for each individual counterparty. In addition, the Fund may require that certain counterparties post cash and/or securities in collateral accounts to cover their net payment obligations for those derivative contracts subject
to ISDA master agreements. If the counterparty fails to perform under these contracts
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
and agreements, the cash and/or securities will be made available to the Fund.
Certain ISDA master agreements
include credit related contingent features which allow counterparties to OTC derivatives to terminate derivative contracts prior to maturity in the event the Funds net assets decline by a stated percentage or the Fund fails to meet the terms
of its ISDA master agreements, which would cause the Fund to accelerate payment of any net liability owed to the counterparty.
For financial reporting purposes, the
Fund does not offset derivative assets and derivative liabilities that are subject to netting arrangements in the Statement of Assets and Liabilities. Bankruptcy or insolvency laws of a particular jurisdiction may impose restrictions on or
prohibitions against the right of offset in bankruptcy, insolvency or other events.
Collateral terms are contract specific for OTC derivatives. For derivatives
traded under an ISDA master agreement, the collateral requirements are typically calculated by netting the mark to market amount for each transaction under such agreement and comparing that to the value of any collateral currently pledged by the
Fund or the Counterparty.
For financial reporting purposes, cash collateral that has been pledged to cover obligations of the Fund, if any, is reported in due
to/from brokers on the Statement of Assets and Liabilities. Generally, the amount of collateral due from or to a party must exceed a minimum transfer amount threshold before a transfer has to be made. To the extent amounts due to the Fund from its
counterparties are not fully collateralized, contractually or otherwise, the Fund bears the risk of loss from counterparty non-performance.
The following table
presents derivative instruments that are subject to enforceable netting arrangements as of June 30, 2014:
Gross Amounts Not Offset in the Statement of Assets and Liabilities
Counterparty
Gross Amounts of Liabilities Presented in Statement of Assets & Liabilities
Financial Instrument
Collateral Received
Net Amount (not less than 0)
PNC Capital Markets LLC
$
10,331
$
$
$
The effect of derivative instruments on the Statement of Operations for the period ended June 30, 2014, is as
follows:
Risk Exposure
Net Realized Gain (Loss) on Derivatives
Net Change in Unrealized Appreciation/ (Depreciation) on Derivatives
Equity Price Risk
$
(1)
$
2,831,757
(3)
Foreign Exchange Risk
(188,984
)(2)
230,025
(4)
(1)
Statement of Operations location: Net realized gain/(loss) on on investments from unaffiliated issuers.
(2)
Statement of Operations location: Net realized gain/(loss) on forward foreign currency exchange contracts.
(3)
Statement of Operations location: Net change in unrealized appreciation/(depreciation) on investments.
(4)
Statement of Operations location: Net change in unrealized appreciation/(depreciation) on forward foreign currency exchange contracts.
For the period ended June 30, 2014, the Funds average volume of derivatives is as follows:
Units/ Contracts
Appreciation/ (Depreciation)
Purchased Options Contracts
401,500
$
Forward Foreign Currency Exchange Contracts
(29,397
)
Written Options Contracts
100
Note 4. Securities Lending
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 and possible investment losses in the investment of collateral. Pursuant to the Funds securities lending 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 bid 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 and receives a fee from the
borrower.
Securities lending transactions are entered into Securities Lending Authorization Agreements (SLAA), which provides the right, in the event of
default (including bankruptcy or insolvency) for the non-defaulting party to liquidate the collateral and calculate a net exposure to the defaulting party or request additional collateral. In the event that a borrower defaults, the Fund, as lender,
would offset the
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
market value of the collateral received against the market value of the securities loaned. The value of the collateral is typically greater than that of the market value of the securities loaned,
leaving the lender with a net amount payable to the defaulting party. However, bankruptcy or insolvency laws of a particular jurisdiction may impose restrictions on or prohibitions against such a right of offset in the event of a SLAA
counterpartys bankruptcy or insolvency. Under the SLAA, the Fund can reinvest cash collateral, or, upon an event of default, resell or repledge the collateral, and the borrower can resell or repledge the loaned securities. The risks of
securities lending also include the risk that the borrower may not provide additional collateral when required or may not return the securities when due. To mitigate this risk, the Fund benefits from a borrower default indemnity provided by State
Street Bank and Trust Company (State Street). State Streets indemnity allows for full replacement of securities lent.
The following table presents
financial instruments that are subject to enforceable netting arrangements as of June 30, 2014:
Gross Amounts Not Offset in the Statement of Assets and Liabilities
Gross Amounts of Liabilities Presented in Statement of Assets & Liabilities
Financial Instrument
Collateral Received
Net Amount (not less than 0)
$
1,009,913
(1)
$
(988,225
)(2)(3)
$
$
21,688
(1)
In some instances, the actual collateral received and/or pledged may be more than the amount shown here due to overcollateralization.
(2)
Represents market value of securities on loan at period end.
(3)
As of June 30, 2014, the market value of securities loaned by the Fund was $988,225. The loaned securities were secured with cash collateral of $1,009,913, which was invested in the State Street Navigator Prime
Securities Lending Portfolio.
Note 5. U.S. Federal Income Tax Information
The character of income and gains to be distributed is determined in accordance with income tax regulations which may differ from U.S. GAAP. These differences include
(but are not limited to) investments organized as partnerships for tax purposes, foreign taxes, investments in futures, losses deferred to off-setting positions, tax treatment of organizational start-up costs, losses deferred due to wash sale
transactions, tax treatment of net investment loss and distributions in excess of net investment income, dividends deemed paid upon shareholder redemption of fund shares and tax attributes from fund reorganizations. Reclassifications are made to the
Funds capital accounts to reflect income and gains available for distribution (or available capital loss carryovers) under income tax regulations. These reclassifications have no impact on net investment income, realized gains or losses, or
net asset
value of the Fund. The calculation of net investment income per share in the Financial Highlights table excludes these adjustments.
For the year ended December 31, 2013, permanent differences chiefly resulting from foreign currency gains and losses, paydown gains and losses, defaulted bonds and
non-deductible excise taxes paid were identified and reclassified among the components of the Funds net assets as follows:
Undistributed Net Investment Income
Accumulated Net Realized Gain (Loss)
Paid-In Capital
$
(2,109,686
)
$
2,213,488
$
(103,802
)
For the year ended December 31, 2013, the Funds tax year end, components of distributable earnings on a tax basis are as
follows:
Undistributed Ordinary Income
Undistributed Long-Term Capital Gains
Other Temporary Differences(2)
Accumulated Capital and Other Losses
Net
Tax Appreciation/ (Depreciation)(1)
$
6,518,318
$
$
934,651
$
(378,643,125
)
$
(43,851,444
)
(1)
Any differences between book-basis and tax-basis net unrealized appreciation/(depreciation) are primarily due to deferral of losses from wash sales, Passive Foreign Investment Company un-reversed inclusions, partnership
adjustments and defaulted bonds.
(2)
Other Temporary Differences is comprised of deferred REIT income.
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
For the
year ended December 31, 2013, the Fund had capital loss carryovers as indicated below. The capital loss carryovers are available to offset future realized capital gains to the extent provided in the Code and regulations promulgated thereunder.
To the extent that these carryover losses are used to offset future capital gains, it is probable that the gains so offset will not be distributed to shareholders because they would be taxable as ordinary income.
2016
2017
2018
2019
No Expiration
Short-Term(1)
No Expiration Long-Term(1)
Total
$
50,723,640
(2)(3)
$
282,026,384
(4)
$
45,893,101
(4)
$
$
$
$
378,643,125
(1)
On December 22, 2010, the Regulated Investment Company Modernization Act of 2010 (the Modernization Act) was signed into law. The Modernization Act modifies several of the Federal income and excise tax
provisions related to RICs. Under the Modernization Act, new capital losses may now be carried forward indefinitely, and retain the character of the original loss as compared with pre-enactment law where capital losses could be carried forward for
eight years, and carried forward as short-term capital losses, irrespective of the character of the original loss.
(2)
These capital loss carryforward amounts were acquired in the reorganizations of Prospect Street High Income Portfolio Inc (PHY) and Prospect Street Income Shares Inc (CNN) into the Fund on
July 18, 2008 and are available to offset future capital gains of the Fund. The Funds ability to utilize the capital loss carryforwards is limited under Internal Revenue Service regulations.
(3)
This capital loss carryforward amount was acquired in the reorganization of Highland Distressed Opportunities, Inc. (HCD) into the Fund on June 12, 2009, and is available to offset future capital gains
of the Fund. The Funds ability to utilize the capital loss carryforwards is limited under Internal Revenue Service regulations.
(4)
The Funds ability to utilize the capital loss carryforward may be limited.
The tax character of distributions paid during the years ended December 31, 2013 and December 31, 2012 (unless
otherwise indicated) were as follows:
Distributions Paid From:
2013
2012
Ordinary Income(1)
$
35,070,929
$
27,149,626
(1)
For tax purposes, short-term capital gains distributions, if any, are considered ordinary income distributions.
Unrealized appreciation and depreciation at June 30, 2014, based on cost of investments for U.S. federal income tax purposes was:
Gross Appreciation
Gross Depreciation
Net Appreciation/ (Depreciation)(1)
Cost
$264,466,706
$271,527,513
$(7,060,807)
$1,360,609,122
(1)
Any differences between book-basis and tax-basis net unrealized appreciation/(depreciation) are primarily due to deferral of losses from wash sales, Passive Foreign Investment Company un-reversed inclusions, partnership
adjustments and defaulted bonds.
Qualified Late Year Ordinary and Post October Losses
Under current laws, certain capital losses realized after October 31 may be deferred and treated as occurring on the first day of the following fiscal year. For the
fiscal year ended December 31, 2013, the Fund did not elect to defer net realized capital losses incurred from November 1, 2012 through December 31, 2013.
Note 6. Credit Agreement
On February 2, 2011, the Fund entered into a
$125,000,000 credit agreement with State Street Bank and Trust Company (the Credit Agreement). Concurrent with entering into the Credit Agreement, the Fund agreed to pay a $125,000 structuring fee, which was amortized ratably
over the term of the agreement. The terms of the Credit Agreement require the Fund to pay 0.15% on the uncommitted balance and pay a spread of 1.25% over LIBOR on amounts borrowed.
On December 14, 2012, the Fund entered into an amendment (the Fifth Amendment) extending the Credit Agreement termination date from January 31,
2013 to December 13, 2013. Additionally, the spread over LIBOR on amounts borrowed declined from 1.10% to 0.95%. The terms of the Credit Agreement continue to require the Fund to pay 0.15% on the uncommitted balance. On January 9, 2014 the
Credit Agreement was increased to $250,000,000, and the termination date was extended to May 8, 2015. As of June 30, 2014, the carrying value of the outstanding debt under the Credit Agreement was $200,000,000 million, excluding accrued
interest that was owed at that date. As of June 30, 2014, the fair value of the outstanding Credit Agreement was estimated to be $200,846,511, and would be categorized as Level 3 within the fair value hierarchy. The fair value was estimated
based on discounting the cash flows owed using a discount rate of 0.50% over the 11 month risk free rate.
For the period ended June 30, 2014, the average
daily note balance was $190,414,365 at a weighted average interest rate of 1.15%. With respect to the Notes, interest expense of $1,058,072 and uncommitted balance fee of $4,521 are included in interest expense in the Statement of Operations.
On May 16, 2013, the Fund entered into a $125,000,000 Committed Facility Agreement with BNP Paribas Prime Brokerage, Inc. (BNPP PB, Inc.) (the
Committed Facility Agreement). The terms of the Committed Facility Agreement require the Fund to pay 0.55% on the uncommitted balance and pay a spread of 0.75% over the 1-month
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
LIBOR on amounts borrowed. The Fund has the right to terminate the agreement upon 90 days prior notice. On May 29, 2013 the Committed Facility Agreement was amended (the First
Amendment), increasing from $125,000,000 to $155,000,000. On December 11, 2013 the Committed Facility Agreement was amended (the Second Amendment), increasing from $155,000,000 to $175,000,000. On May 6, 2014, the Committed
Facility Agreement was amended (the Third Amendment), increasing from $175,000,000 to $200,000,000. As of June 30, 2014, the carrying value of the Committed Facility Agreement was $200,000,000. The fair value of the outstanding
Committed Facility Agreement was estimated to be $200,181,164, and would be categorized as Level 3 within the fair value hierarchy. The fair value was estimated based on discounting the cash flows owed using a discount rate of 0.50% over the
90 days risk free rate.
For the period ended June 30, 2014, the average daily note balance was $184,076,555 at a weighted average interest rate of 0.95%.
With respect to the Notes, interest expense of $826,783 and uncommitted balance fee of $46 are included in interest expense in the Statement of Operations.
Note
7. Asset Coverage
The Fund is required to maintain 300% asset coverage with respect to amounts outstanding under the Credit Agreement and the Notes. Asset
coverage is calculated by subtracting the Funds total liabilities, not including any amount representing bank loans and senior securities, from the Funds total assets and dividing the result by the principal amount of the borrowings
outstanding. As of the dates indicated below, the Funds debt outstanding and asset coverage was as follows:
The Investment Adviser to the Fund receives an annual fee, paid monthly, in an amount equal to 1.00% of the average daily value of the Funds Managed Assets. The
Funds 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 Funds investment objectives and policies, and/or (iv) any other means.
Administration Fee
The Investment Adviser provides administrative services to the Fund. For its services, the Investment Adviser receives an annual fee, payable monthly, in an amount equal
to 0.20% of the average weekly value of the Funds Managed Assets. Under a separate sub-administration agreement, the Investment Adviser has delegated certain administrative functions to State Street Bank and Trust Company. The Investment
Adviser pays State Street Bank and Trust Company directly for these sub-administration services.
Fees Paid to Officers and Trustees
Each Trustee who is not an interested person of the Fund as defined in the 1940 Act (the Independent Trustees) receives an annual retainer of
$150,000 payable in quarterly installments and allocated among each portfolio in the Highland Fund Complex based on relative net assets. The Highland Fund Complex consists of all of the registered investment companies advised by the
Investment Adviser and any affiliates as of the period covered by this annual report. The Fund pays no compensation to its one interested Trustee or any of its officers, all of whom are employees of the Investment Adviser.
Note 9. Disclosure of Significant Risks and Contingencies
The primary risks
of investing in the Fund are described below in alphabetical order:
Concentration Risk
The Fund may focus its investments in instruments of only a few companies. The concentration of the Funds 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.
Counterparty Credit Risk
Counterparty credit risk is the potential loss the
Fund may incur as a result of the failure of a counterparty or an issuer to make payments according to the terms of a contract. Counterparty credit risk is measured as the loss the
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
Fund would record if its counterparties failed to perform pursuant to the terms of their obligations to the Fund. Because the Fund may enter into over-the-counter forwards, options, swaps and
other derivative financial instruments, the Fund may be exposed to the credit risk of its counterparties. To limit the counterparty credit risk associated with such transactions, the Fund conducts business only with financial institutions judged by
the Investment Adviser to present acceptable credit risk.
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 companys continuing ability to meet principal and/ or interest payments. Investments in high yield debt and high yield Senior Loans may result in greater net asset value fluctuation than if the Fund did not make such
investments.
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 corporate debt obligation experiencing non-payment and a potential decrease in the NAV of the Fund.
Currency Risk
A portion of the Funds assets may be quoted or
denominated in non-U.S. currencies. These securities may be adversely affected by fluctuations in relative currency exchange rates and by exchange control regulations. The Funds investment performance may be negatively affected by a
devaluation of a currency in which the Funds investments are quoted or denominated. Further, the Funds investment performance may be significantly affected, either positively or negatively, by currency exchange rates because the U.S.
dollar value of securities quoted or denominated in another currency will increase or decrease in response to changes in the value of such currency in relation to the U.S. dollar.
Foreign Securities Risk
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 Funds 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.
Forward Foreign Currency Exchange Contracts Risk
The Fund is subject to foreign currency exchange rate risk in the normal course of pursuing its investment objectives. The Fund may use forward contracts to gain
exposure to, or hedge against changes in the value of foreign currencies. A forward contract represents a commitment for the future purchase or sale of an asset at a specified price on a specified date. Upon entering into such contracts, daily
fluctuations in the value of the contract are recorded for financial statement purposes as unrealized gains or losses by the Fund. At the expiration of the contracts the Fund realizes the gain or loss. Upon entering into such contracts, the Fund
bears the risk of exchange rates moving unexpectedly, in which case, the Fund may not achieve the anticipated benefits of the forward contracts and may realize a loss. With forwards, there is counterparty credit risk to the Fund because the forwards
are not exchange-traded, and there is no clearinghouse to guarantee the forwards against default.
Hedging Transactions Risk
The Fund may engage in hedging, the practice of attempting to offset a potential loss in one position by establishing an opposite position in another
investment. Hedging strategies in general are usually intended to limit or reduce investment risk, but can also be expected to limit or reduce the potential for profit. For example, if the Fund has taken a defensive posture by hedging its portfolio,
and stock prices advance, the return to investors will be lower than if the portfolio had not been hedged. No assurance can be given that any particular hedging strategy will be successful or that the Investment Adviser will elect to use a hedging
strategy at a time when it is advisable.
Illiquid Securities Risk
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 Advisers 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 Funds investments, especially
those in financially distressed companies, may require a long holding period prior to profitability.
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
Indemnification Risk
The Fund
has a variety of indemnification obligations under contracts with its service providers. The Funds maximum exposure under these arrangements is unknown. However, the Fund has not had prior claims or losses pursuant to these contracts and
expect the risk of loss to be remote.
Investments in Foreign Markets Risk
Investments in foreign markets involve special risks and considerations not typically associated with investing in the United States. These risks include revaluation of
currencies, high rates of inflation, restrictions on repatriation of income and capital, and adverse political and economic developments. Moreover, securities issued in these markets may be less liquid, subject to government ownership controls,
tariffs and taxes, subject to delays in settlements, and their prices may be more volatile.
The Fund may be subject to capital gains and repatriation taxes imposed
by certain countries in which they invest. Such taxes are generally based on income and/or capital gains earned or repatriated. Taxes are accrued based upon net investment income, net realized gains and net unrealized appreciation as income and/or
capital gains are earned.
Leverage Risk
The Fund may use leverage in
their investment program, including the use of borrowed funds and investments in certain types of options, such as puts, calls and warrants, which may be purchased for a fraction of the price of the underlying securities. While such strategies and
techniques increase the opportunity to achieve higher returns on the amounts invested, they also increase the risk of loss. To the extent the Fund purchases securities with borrowed funds, its net assets will tend to increase or decrease at a
greater rate than if borrowed funds are not used. If the interest expense on borrowings were to exceed the net return on the portfolio securities purchased with borrowed funds, the Funds use of leverage would result in a lower rate of return
than if the Fund were not leveraged.
Options Risk
There are several
risks associated with transactions in options on securities. For example, there are significant
differences between the securities and options markets that could
result in an imperfect correlation between these markets, causing a given transaction not to achieve its objectives. A transaction in options or securities may be unsuccessful to some degree because of market behavior or unexpected events.
When the Fund writes a covered call option, the Fund forgoes, during the options life, the opportunity to profit
from increases in the market value of the security covering the call option above the sum of the premium and the strike price of the call, but retains the risk of loss should the price of the underlying security decline. The writer of an option has
no control over the time when it may be required to fulfill its obligation and once an option writer has received an exercise notice, it must deliver the underlying security in exchange for the strike price.
When the Fund writes a covered put option, the Fund bears the risk of loss if the value of the underlying stock declines below the exercise price minus the put premium.
If the option is exercised, the Fund could incur a loss if it is required to purchase the stock underlying the put option at a price greater than the market price of the stock at the time of exercise plus the put premium the Fund received when it
wrote the option. While the Funds potential gain in writing a covered put option is limited to distributions earned on the liquid assets securing the put option plus the premium received from the purchaser of the put option, the Fund risks a
loss equal to the entire exercise price of the option minus the put premium.
Restricted Securities Risk
Restricted securities (i.e., securities acquired in private placement transactions) and illiquid securities may offer higher yields than comparable publicly traded
securities. The Fund, however, may not be able to sell these securities when the Investment Adviser considers it desirable to do so or, to the extent they are sold privately, may have to sell them at less than the price of otherwise comparable
securities. Restricted securities are subject to limitations on resale which can have an adverse effect on the price obtainable for such securities. Also, if in order to permit resale the securities are registered under the Securities Act at the
Funds expense, the Funds expenses would be increased.
Short-Selling Risk
Short sales by the Fund that are not made where there is an offsetting long position in the asset that it is being sold short theoretically involve unlimited loss
potential since the market price of securities sold short may continuously increase. Short selling allows the Fund to profit from declines in market prices to the extent such decline exceeds the transaction costs and 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. Purchasing securities to
close out the short position can itself cause
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
June 30, 2014
NexPoint Credit Strategies Fund
the price of securities to rise further, thereby exacerbating the loss. The Fund may mitigate such losses by replacing the securities sold short before the market price has increased
significantly. Under adverse market conditions, the Fund might have difficulty purchasing securities to meet margin calls on its short sale delivery obligations, and might have to sell portfolio securities to raise the capital necessary to meet its
short sale obligations at a time when fundamental investment considerations would not favor such sales.
Troubled, Distressed or Bankrupt Companies Risk
The Fund invests in companies that are troubled, in distress or bankrupt. As such, they are subject to a multitude of
legal, industry, market, environmental and governmental forces that make analysis of these companies inherently difficult. 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.
Note 10. Investment Transactions
For the period ended June 30, 2014,
the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were $415,029,466 and $342,451,236, respectively.
Note 11. Affiliated Issuers
Under Section 2(a)(3) of the 1940 Act, a portfolio company is defined as affiliated if a Fund owns five percent or more of its outstanding voting
securities. The Fund held at least five percent of the outstanding voting securities of the following companies as of June 30, 2014:
Market Value
Issuer
Shares at December 31, 2013
Shares at June 30, 2014
December 31, 2013
June 30, 2014
Affiliated Income
Purchases
Sales
Communications Corp of America (Common Stocks)
2,010,616
2,010,616
$
16,084,928
$
16,688,113
$
$
$
Endurance Business Media, Inc., Class A (Common Stocks)
6,480
6,480
Freedom REIT (Common Stocks)
2,845,299
6,713,992
42,964,014
102,455,525
58,371,834
LLV Holdco, LLC (Common Stocks)
26,869
26,870
1,304,916
Media General, Inc. (Common Stocks)
4,938,971
4,938,971
111,620,744
101,397,074
9,828,235
13,696,929
$
170,669,686
$
221,845,628
$
$
58,371,834
$
(1)
No longer an affiliate as of June 30, 2014.
Note 12. New Accounting Pronouncements
ASU 2013-08
In June 2013, FASB issued an update (ASU
2013-08) to ASC Topic 946, Financial Services Investment Companies (Topic 946). ASU 2013-08 amends the guidance in Topic 946 for determining whether an entity qualifies as an investment company and requires certain
additional disclosures. ASU 2013-08 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2013. Management has determined that ASU 2013-08 does not impact the Funds financial statements.
Note 13. Subsequent Events
Management has evaluated the impact of all subsequent events on the Fund through the date the financial statements were issued, and has determined that there were no
subsequent events.
The Investment Adviser and its affiliates manage other accounts, including registered and private funds and individual accounts. Although investment decisions for the
Fund are made independently from those of such other accounts, the Investment Adviser may, consistent with applicable law, make investment recommendations to other clients or accounts that may be the same or different from those made to the Fund,
including investments in different levels of the capital structure of a company, such as equity versus senior loans, or that involve taking contradictory positions in multiple levels of the capital structure. The Investment Adviser 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, this may create situations where a client could be disadvantaged because of the investment activities conducted by the Investment Adviser for other client accounts. When the Fund and one or more of such
other accounts is prepared to invest in, or desires to dispose of, the same security, available investments or opportunities for each will be allocated in a manner believed by the Investment Adviser to be equitable to the fund and such other
accounts. The Investment Adviser also may aggregate orders to purchase and sell securities for the Fund and such other accounts. Although the Investment Adviser believes that, over time, the potential benefits of participating in volume transactions
and negotiating lower transaction costs should benefit all accounts including the Fund, in some cases these activities may adversely affect the price paid or received by the Fund or the size of the position obtained or disposed of by the Fund.
Tax Information
For shareholders that do not have a December 31, 2013 tax
year end, this notice is for informational purposes only. For shareholders with a December 31, 2013 tax year end, please consult your tax adviser a to the pertinence of this notice. For the fiscal year ended December 31, 2013, the Fund hereby
designates the following items with regard to distributions paid during the year.
Qualified Dividends and Corporate Dividends Received Deduction
This report has been prepared for shareholders of NexPoint Credit Strategies Fund (the Fund). The Fund mails
one shareholder report to each shareholder address. If you would like more than one report, please call shareholder services at 1-866-351-4440 to request that additional reports be sent to you.
A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to its portfolio securities, and the Funds proxy voting
record for the most recent 12-month period ended June 30, are available (i) without charge, upon request, by calling
1-866-351-4440 and (ii) on the SECs website at http://www.sec.gov.
The
Fund files its complete schedule of portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. The Funds Forms N-Q are
available on the SECs website at http://www.sec.gov and also may be reviewed and copied at the SECs Public Reference Room in Washington, DC. Information on the Public Reference Room may be obtained by calling 1-800-SEC-0330. Shareholders may also obtain the Form N-Q by visiting the Funds website
at www.NexPointAdvisors.com.
On July 2, 2013, the Fund submitted a CEO annual certification to the New York Stock Exchange (NYSE) on which the
Funds principal executive officer certified that he was not aware, as of the date, of any violation by the Fund of the NYSEs Corporate Governance listing standards. In addition, as required by Section 302 of the Sarbanes-Oxley Act
of 2002 and related SEC rules, the Funds principal executive officer and principal financial officer made quarterly certifications, included in filings with the SEC on Forms N-CSR and N-Q relating to, among other things, the Funds disclosure controls and procedures and internal controls over financial reporting, as applicable.
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.
(b)
Not applicable.
Item 7.
Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies.
Not applicable.
Item 8. Portfolio Managers of Closed-End Management Investment Companies.
There has been no change, as of the date of this filing, in any of the portfolio managers identified in response to paragraph (a)(1) of this Item in the
registrants most recently filed annual report on Form N-CSR.
Item 9.
Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers.
Not applicable.
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
registrants board of directors.
The registrants principal executive and principal financial officers, or persons performing similar functions, have concluded that the
registrants 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 registrants 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 registrants second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial
reporting.
Item 12. Exhibits.
(a)(1)
Not applicable.
(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.
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.
NEXPOINT CREDIT STRATEGIES FUND
By (Signature and Title):
/s/ Ethan Powell
Ethan Powell
Executive Vice President and Principal Executive Officer
(Principal Executive Officer)
Date: September 8, 2014
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/ Ethan Powell
Ethan Powell
Executive Vice President and Principal Executive Officer