<Page>
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 811-08955
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HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
(Exact name of Registrant as specified in charter)
13455 Noel Road, Suite 1300
Dallas, Texas 75240
(Address of principal executive offices)
James D. Dondero
Highland Capital Management, L.P.
13455 Noel Road, Suite 1300
Dallas, Texas 75240
COPIES TO:
Stuart H. Coleman, Esq.
Stroock & Stroock & Lavan LLP
180 Maiden Lane
New York, New York 10038
(Name and address of agent for service)
Registrant's telephone number, including area code: (877) 532-2834
Date of fiscal year end: 8/31
----
Date of reporting period: 8/31/2004
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<Page>
FORM N-CSR
ITEM 1. REPORTS TO STOCKHOLDERS.
<Page>
[GRAPHIC]
HIGHLAND INSTITUTIONAL
FLOATING RATE INCOME FUND
ANNUAL REPORT
AUGUST 31, 2004
[HIGHLAND FUNDS LOGO]
MANAGED BY
HIGHLAND CAPITAL MANAGEMENT, L.P.
<Page>
TABLE OF CONTENTS
<Table>
Fund Profile 1
Performance Information 2
Understanding Your Expenses 3
Economic Update 4
Portfolio Managers' Report 5
Financial Statements 7
Investment Portfolio 8
Statement of Assets and Liabilities 26
Statement of Operations 27
Statement of Changes in Net Assets 28
Statement of Cash Flows 29
Statement of Assets and Liabilities 30
Statement of Operations 31
Statement of Changes in Net Assets 32
Notes to Financial Statements 33
Financial Highlights 40
Report of Independent Registered
Public Accounting Firm 42
Unaudited Information 43
Trustees 44
Officers 45
Important Information
About This Report 46
</Table>
Economic and market conditions change frequently. There is no assurance that the
trends described in this report will continue or commence.
NOT FDIC MAY LOSE VALUE
INSURED NO BANK GUARANTEE
TO OUR FELLOW SHAREHOLDERS
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
DEAR SHAREHOLDER:
I am pleased to submit this annual report for the period ended August 31, 2004.
I am also pleased to have announced on April 15, 2004 that Highland Capital
Management, L.P. ("Highland") entered into a new investment advisory agreement
with the Highland Institutional Floating Rate Income Fund, formerly Columbia
Institutional Floating Rate Income Fund. The agreement was approved at a special
meeting of the Fund's shareholders held on July 30, 2004. As you may know, since
April 15, 2004, when the investment management of the Fund was transferred to
Highland and the distribution of the Fund to PFPC Distributors, Inc., Highland
acted as advisor to the Fund under an interim agreement pending final
shareholder approval.
At the shareholder meeting, five new Trustees were elected to the Fund's Board
of Trustees. The Fund's Board of Trustees now consists of: Timothy K. Hui, Scott
F. Kavanaugh, James F. Leary, Bryan A. Ward and R. Joseph Dougherty. Mr.
Dougherty is the only Trustee affiliated with Highland. Biographical information
for each Trustee can be found in the report that follows.
Effective October 18, 2004, PFPC Inc. ("PFPC") replaced Columbia Funds Services,
Inc. as the Fund's transfer agent. As of that date, PFPC assumed all account
servicing responsibilities for the Fund.
Some changes that will affect shareholders of the Highland Institutional
Floating Rate Income Fund include the following:
Effective October 18, 2004, the name of the Fund changed from Columbia
Institutional Floating Rate Income Fund to Highland Institutional Floating Rate
Income Fund and you should anticipate new fund CUSIP numbers. (A CUSIP is a
unique identification number assigned to each class of a fund by the Committee
on Uniform Security Identification Procedures.) Ticker symbols for the Fund will
remain the same. A list of the new CUSIP numbers and other information related
to these changes are available online at www.highlandfunds.com, our new website.
Please don't hesitate to contact your financial advisor or call Shareholder
Services at 877-665-1287 for more information.
In the report that follows, your portfolio manager talks in depth about
investment strategies and other factors that affected your Fund's performance
during the period. I encourage you to read the report carefully.
I thank you for your business and I look forward to continuing to serve your
investment needs.
Sincerely,
/s/ James D. Dondero
James D. Dondero
President
<Page>
FUND PROFILE
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
The information below gives you a snapshot of your fund at the end of the
reporting period. Your fund is actively managed and the composition of its
portfolio will change over time.
QUALITY BREAKDOWN AS OF 08/31/04 (%)
<Table>
Baa 0.3
Ba 27.2
B 53.9
Caa 5.3
NR 13.3
</Table>
TOP 5 SECTORS AS OF 08/31/04 (%)
<Table>
Cable & Satellite Television 9.3
Utilities 6.5
Health Care 5.6
Chemicals/Plastics 5.4
Telecommunications/Cellular 4.2
</Table>
TOP 10 ISSUERS AS OF 08/31/04 (%)
<Table>
Nextel Finance 1.6
Hilton Head Communications 1.5
Century Cable 1.5
Key Automotive Group 1.4
Charter Communications 1.3
UPC Financing Partnership 1.3
Mission Energy Holdings 1.3
Olympus Cable Holdings 1.1
Conseco 1.1
Qwest 1.1
</Table>
Quality is calculated as a percentage of total investments. Sector and issuers
are calculated as a percentage of net assets.
[SIDENOTE]
SUMMARY
- - FOR THE ONE-YEAR PERIOD THAT ENDED AUGUST 31, 2004, THE FUND RETURNED 10.25%.
OBJECTIVE
The Fund invests all of its investable assets in Highland Floating Rate Limited
Liability Company (the "Portfolio"). The Portfolio seeks a high level of current
income, consistent with preservation of capital
TOTAL NET ASSETS
$66.0 million
1
<Page>
PERFORMANCE INFORMATION
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
[CHART]
VALUE OF A $10,000 INVESTMENT 12/17/98 - 08/31/04
<Table>
<Caption>
COLUMBIA INSTITUTIONAL CSFB LEVERAGED
FLOATING RATE INCOME LOAN INDEX
12/17/98 $ 10,000 $ 10,000
12/31/98 $ 10,012 $ 10,000
1/31/99 $ 10,079 $ 10,026
2/28/99 $ 10,168 $ 9,983
3/31/99 $ 10,253 $ 10,044
4/30/99 $ 10,330 $ 10,117
5/31/99 $ 10,408 $ 10,247
6/30/99 $ 10,484 $ 10,339
7/31/99 $ 10,555 $ 10,407
8/31/99 $ 10,596 $ 10,370
9/30/99 $ 10,667 $ 10,345
10/31/99 $ 10,721 $ 10,330
11/30/99 $ 10,775 $ 10,397
12/31/99 $ 10,855 $ 10,468
1/31/2000 $ 10,937 $ 10,570
2/29/2000 $ 11,026 $ 10,604
3/31/2000 $ 11,064 $ 10,521
4/30/2000 $ 11,134 $ 10,559
5/31/2000 $ 11,231 $ 10,647
6/30/2000 $ 11,315 $ 10,712
7/31/2000 $ 11,417 $ 10,789
8/31/2000 $ 11,499 $ 10,844
9/30/2000 $ 11,566 $ 10,879
10/31/2000 $ 11,624 $ 10,885
11/30/2000 $ 11,657 $ 10,908
12/31/2000 $ 11,706 $ 10,985
1/31/2001 $ 11,800 $ 11,051
2/28/2001 $ 11,834 $ 11,146
3/31/2001 $ 11,792 $ 11,159
4/30/2001 $ 11,681 $ 11,112
5/31/2001 $ 11,799 $ 11,245
6/30/2001 $ 11,822 $ 11,258
7/31/2001 $ 11,950 $ 11,286
8/31/2001 $ 12,065 $ 11,376
9/30/2001 $ 11,945 $ 11,159
10/31/2001 $ 11,749 $ 10,985
11/30/2001 $ 11,849 $ 11,158
12/31/2001 $ 11,961 $ 11,274
1/31/2002 $ 12,125 $ 11,336
2/28/2002 $ 12,023 $ 11,293
3/31/2002 $ 12,174 $ 11,424
4/30/2002 $ 12,319 $ 11,546
5/31/2002 $ 12,368 $ 11,538
6/30/2002 $ 12,204 $ 11,363
7/31/2002 $ 11,896 $ 11,191
8/31/2002 $ 11,776 $ 11,158
9/30/2002 $ 11,662 $ 11,183
10/31/2002 $ 11,606 $ 11,033
11/30/2002 $ 11,749 $ 11,223
12/31/2002 $ 11,931 $ 11,399
1/31/2003 $ 12,062 $ 11,553
2/28/2003 $ 12,086 $ 11,613
3/31/2003 $ 12,217 $ 11,651
4/30/2003 $ 12,499 $ 11,815
5/31/2003 $ 12,793 $ 11,974
6/30/2003 $ 13,002 $ 12,143
7/31/2003 $ 13,075 $ 12,225
8/31/2003 $ 13,130 $ 12,252
9/30/2003 $ 13,322 $ 12,375
10/31/2003 $ 13,502 $ 12,486
11/30/2003 $ 13,710 $ 12,577
12/31/2003 $ 13,863 $ 12,655
1/31/2004 $ 14,121 $ 12,787
2/29/2004 $ 14,169 $ 12,826
3/31/2004 $ 14,219 $ 12,879
4/30/2004 $ 14,298 $ 12,938
5/31/2004 $ 14,330 $ 12,968
6/30/2004 $ 14,403 $ 13,051
7/31/2004 $ 14,439 $ 13,097
8/31/2004 $ 14,475 $ 13,120
</Table>
The graph and table do not reflect the deduction of taxes that a shareholder
would pay on fund distributions or the redemption of fund shares. The Credit
Suisse First Boston (CSFB) Leveraged Loan Index is an unmanaged index that
tracks the performance of senior floating rate bank loans. Unlike mutual funds,
indices are not investments, do not incur fees or expenses and are not
professionally managed. It is not possible to invest directly in an index.
Securities in the fund may not match those in an index. Index performance is
from December 31, 1998.
AVERAGE ANNUAL TOTAL RETURN AS OF 08/31/04 (%)
<Table>
<Caption>
INCEPTION 12/17/98
1-year 10.25
5-year 6.44
Life 6.70
</Table>
AVERAGE ANNUAL TOTAL RETURN AS OF 06/30/04 (%)
<Table>
1-year 10.77
5-year 6.56
Life 6.82
</Table>
Investors should consider the investment objectives, risks, charges and expenses
of the Highland Funds carefully before investing. A prospectus with this and
other information about the Fund may be obtained at 1-877-665-1287 or
www.highlandfunds.com. The prospectus should be read carefully before investing.
All results shown assume reinvestment of distributions. Performance results
reflect any voluntary waivers or reimbursements of Fund expenses by the Advisor.
Absent these waivers and reimbursement arrangements, performance results would
have been lower. Inception returns are calculated from December 17, 1998.
[SIDENOTE]
PERFORMANCE OF A $10,000 INVESTMENT 12/17/98 - 08/31/04
<Table>
The fund $ 14,475
</Table>
Performance data quoted represents past performance and current performance may
be lower or higher. Past performance is no guarantee of future results. The
investment return and principal value will fluctuate so that shares, when
redeemed, may be worth more or less than the original cost. Please visit
www.highlandfunds.com for daily net asset values and most recent month-end
performance updates.
2
<Page>
UNDERSTANDING YOUR EXPENSES
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
As a fund shareholder, you incur two types of costs. There are transaction
costs, which generally include sales charges on purchases and may include
redemption or exchange fees. There are also continuing costs, which generally
include investment advisory and/or Rule 12b-1 fees, and other fund expenses. The
information on this page is intended to help you understand your ongoing costs
of investing in the fund and to compare this cost with the continuing costs of
investing in other funds.
ANALYZING YOUR FUND'S EXPENSES
To illustrate these ongoing costs, we have provided an example and calculated
the expenses paid by investors in each share class during the reporting period.
The information in the following table is based on an initial investment of
$1,000, which is invested at the beginning of the reporting period and held for
the entire period. Expense information is calculated two ways and each method
provides you with different information. The amount listed in the "actual"
column is calculated using the fund's actual operating expenses and total return
for the period. The amount listed in the "hypothetical" column for each share
class assumes that the return each year is 5% before expenses and includes the
fund's actual expense ratio. You should not use the hypothetical account values
and expenses to estimate either your actual account balance at the end of the
period or the expenses you paid during this reporting period.
MARCH 1, 2004 - AUGUST 31, 2004
<Table>
<Caption>
ACCOUNT VALUE AT THE ACCOUNT VALUE AT THE EXPENSES PAID FUND'S ANNUALIZED
BEGINNING OF THE PERIOD ($) END OF THE PERIOD ($) DURING THE PERIOD ($) EXPENSE RATIO (%)
ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL ACTUAL HYPOTHETICAL
1,000.00 1,000.00 1,009.17 1,008.87 3.79 3.79 0.75
</Table>
Expenses paid during the period are equal to the fund's annualized expense
ratio, multiplied by the average account value over the period, then multiplied
by the number of days in most recent fiscal half-year and divided by 366.
Had the advisor or its affiliates not waived or reimbursed a portion of
expenses, total return would have been reduced.
It is important to note that the expense amounts shown in the table are meant to
highlight only continuing costs of investing in the fund and do not reflect any
transactional costs, such as sales charges, redemption or exchange fees.
Therefore, the hypothetical examples provided will not help you determine the
relative total costs of owning different funds. If these transactional costs
were included, your costs would have been higher.
COMPARE WITH OTHER FUNDS
Since all funds are required to include the same hypothetical calculations about
expenses in shareholder reports, you can use this information to compare the
ongoing cost of investing in the fund with other funds. To do so, compare the 5%
hypothetical example with the 5% hypothetical examples that appear in the
shareholder reports of other funds. As you compare hypothetical examples of
other fund companies, it is important to note that hypothetical examples are
meant to highlight the continuing cost of investing in a fund and do not reflect
any transactional costs, such as sales charges or redemption or exchange fees.
[SIDENOTE]
ESTIMATING YOUR ACTUAL EXPENSES
To estimate the expenses that you paid over the period, first you will need your
account balance at the end of the period:
- - For shareholders who receive their account statements from PFPC Inc., your
account balance is available online at www.highlandfunds.com or by calling
Shareholder Services at 877.665.1287
- - For shareholders who receive their account statements from their brokerage
firm, contact your brokerage firm to obtain your account balance.
1. Divide your ending account balance by $1,000. For example, if an account
balance was $8,600 at the end of the period, the result would be 8.6
2. In the section of the table below titled "Expenses paid during the period,"
locate the amount for your share class. You will find this number is in the
column labeled "actual." Multiply this number by the result from step 1. Your
answer is an estimate of the expenses you paid on your account during the
period
3
<Page>
ECONOMIC UPDATE
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
Despite occasional uncertainty about jobs and consumer spending, the US economy
grew at a pace of more than 4.5% during the 12-month period that began September
1, 2003 and ended August 31, 2004. Growth slowed in the final months of the
period, and many economists lowered their expectations for the balance of 2004.
Nevertheless, the US economy remained on solid ground.
Consumer confidence seesawed, mostly in reaction to changing job data, which
dominated much of the economic news during the year. The Conference Board
reported that confidence declined on weak job figures early in 2004. Confidence
rose after the US labor markets added more than 1.2 million new jobs between
March and May. However, disappointing job creation in June and July curbed
consumer enthusiasm again in August.
Consumers expressed their confidence in the economy by spending on retail goods,
autos and housing. Low mortgage rates continued to fuel a red-hot housing
market. However, consumer spending declined in two of the last three months of
the period, the first such pullback in a year. Businesses stepped into the gap
and helped fuel the economy during the period. Industrial production rose and
factories utilized more of their capacity. Spending on technology and capital
equipment picked up, and outlays for office and warehouse construction turned
the corner after a three-year downturn.
BONDS DELIVER RESPECTABLE RETURNS
Despite periods of interest rate volatility, the US bond market delivered
respectable gains. The yield on the 10-year US Treasury bond drifted generally
lower for the first eight months of the period. Then it rose sharply as the
economy strengthened, the employment picture brightened and investors began to
anticipate a shift in the Federal Reserve Board's policy on short-term interest
rates. The Fed delivered on these expectations and raised the federal funds
rate, a key short-term rate, twice during the period--from 1.0% to 1.25% in June
and to 1.50% in August.(1)
A shaky stock market, higher energy prices and some weak economic data gave the
bond market a boost in July and August as the 10-year Treasury yield fell to
4.1%, ending the period lower than where it started. As a result, the Lehman
Brothers Aggregate Bond Index, a broad measure of investment grade bond market
performance, returned 6.13%. Municipals were the best performers among
investment-grade bonds, returning 7.11% as measured by the Lehman Municipal Bond
Index. However, the high-yield sector outdistanced all other sectors. The
Merrill Lynch US High Yield, Cash Pay Index returned 13.64%.
US STOCKS OUTPERFORMED BONDS
Buoyed by strong gains at the beginning of the period, the S&P 500 Index
returned 11.46% during this 12-month reporting period. However, concerns about
new terror threats and higher interest rates and energy prices sidelined
investors as the period wore on. Late in the period, leadership passed from
small-cap stocks, which were strong performers early in the period, to mid- and
large-cap stocks. Value stocks continued to lead growth stocks. Energy stocks
and real estate investment trusts were the best-performing sectors for the
period.
(1) The federal funds rate was raised to 1.75% in September.
[SIDENOTE]
SUMMARY
FOR THE ONE-YEAR PERIOD ENDED AUGUST 31, 2004
- - Performance in the fixed income universe was led by high yield bonds. As
measured by the Merrill Lynch US High Yield, Cash Pay Index, this sector
posted a return more than seven percentage points higher than the return for
investment-grade bonds, as measured by the Lehman Brothers Aggregate Bond
Index.
- - The US stock market rose as the economy strengthened. Both the Russell 3000
Index, which tracks approximately 98% of the US stock market, and the S&P 500
Index posted double-digit returns this period.
[GRAPHIC]
<Table>
LEHMAN BROTHERS AGGREGATE BOND INDEX 6.13
MERRILL LYNCH US HIGH YIELD, CASH PAY INDEX 13.64
</Table>
[GRAPHIC]
<Table>
RUSSELL 3000 INDEX 11.31
S&P 500 INDEX 11.46
</Table>
4
<Page>
PORTFOLIO MANAGERS' REPORT
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
For the 12-month period ended August 31, 2004, the Highland Institutional
Floating Rate Income Fund returned 10.25%. That was greater than the return of
the fund's benchmark, the CSFB Leveraged Loan Index, which was 7.05% for the
period. The fund also outperformed the Lipper Loan Participation Funds Category
average, which was 8.82%.(1) These high returns reflect an advantageous
environment for all types of credit instruments. We believe the fund was able to
outperform because of favorable security selection and sector allocation.
A STRONG CREDIT ENVIRONMENT
The period ended August 31, 2004 was another strong year for the credit markets,
fueled by improved earnings, strong job growth and increased demand for
floating-rate loans. However, financial markets faced pressure from the
political instability in the Middle East, high oil prices and increased interest
rates. During both its June 30 and August 10 meetings, the Federal Reserve
increased the fed funds rate 25 basis points, bringing the fed funds rate to
1.50%. Leveraged loan default rates continued to drop as corporate balance
sheets improved.
CABLE AND TELECOM - RESPECTABLE GAINS
Cable and satellite television, which constituted 9.3% of the Portfolio's net
assets, performed well for the portfolio. Century Cable and Olympus Cable (1.5%
and 1.1% of net assets, respectively) had another strong year for the portfolio.
Both of these holdings are wholly-owned subsidiaries of Adelphia, a cable
industry bellwether.
The portfolio's position in telecommunications contributed significantly to the
Fund's strong performance. Telecommunications, which accounted for 8.6% of the
portfolio's net assets, showed continued strength for the second year. Cricket
Communications was a very solid performer for the portfolio. After trading well
above par, the bank loans converted to Cricket Communications notes and equity
in Leap Wireless during the year. Both the notes and equity had strong
performance through the end of the period. Cricket Communications and Leap
Wireless were 0.1% and 0.2% of net assets, respectively.
(1) Lipper, Inc., a widely respected data provider in the industry, calculates
an average total return for mutual funds with similar investment objectives
as the fund. This fund falls under the Lipper Loan Participation Category
average.
[SIDENOTE]
NET ASSET VALUE PER SHARE
AS OF 08/31/04
<Table>
The fund 9.79
</Table>
DISTRIBUTIONS DECLARED PER SHARE
09/01/03 - 08/31/04
<Table>
The fund 0.42
</Table>
SEC YIELD AS OF 08/31/04 (%)
<Table>
The fund 4.16
</Table>
The 30-day SEC yields reflect the Fund's earning power net of expenses,
expressed as an annualized percentage of the public offering price at the end of
the period. If the advisor or its affiliates had not waived certain fund
expenses, the SEC yields would have been lower.
HOLDINGS DISCUSSED IN THIS REPORT
AS OF 08/31/04 (%)
<Table>
Century Cable 1.5
Olympus Cable 1.1
Cricket Communications 0.1
Leap Wireless 0.2
</Table>
Your fund is actively managed and the composition of its portfolio will change
over time. Information provided is calculated as a percentage of net assets.
5
<Page>
The fund did not experience any major defaults during the period. Many lower
rated companies have improved their financial condition via newfound access to
the high yield bond market. As a result, lower quality credits performed well
again this year.
/s/ Mark Okada
/s/ Joe Dougherty
Mark Okada and Joe Dougherty have been portfolio managers of the Highland
Institutional Floating Rate Income Fund since April 15, 2004.
Just like any other investment, floating rate loan investments present financial
risks. Defaults on the loans in the portfolio could reduce the fund's net asset
value and its distributions, as could nonpayment of scheduled interest and
principal. Prepayment of principal by a borrower could mean that the portfolio
managers have to replace the loan with a lower-yielding security, which could
affect the valuation of the portfolio's holdings.
The fund is a continuously offered, closed-end management investment company and
provides limited liquidity through a quarterly tender offer for between 5% and
25% of outstanding shares. Each quarter, the fund's trustees must approve the
actual tender amount. Please read the prospectus carefully for more details.
The Portfolio may invest a high percentage of assets in a limited number of
loans, so the default of any individual holding can have a greater impact on the
fund's net asset value than could a default in a more diversified portfolio.
Floating rate loans are not covered by FDIC insurance or other guarantees
relating to timely payment of principal and interest.
Since economic and market conditions change frequently, there can be no
assurance that the trends described here will continue or that the forecasts
will come to pass. The opinions expressed are those of the portfolio managers
and are subject to change.
Prior investment returns are not indicative of future results.
6
<Page>
FINANCIAL STATEMENTS
AUGUST 31, 2004 HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
A GUIDE TO UNDERSTANDING YOUR 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, industry, country or geographic region (if
applicable) to demonstrate areas of concentration and diversification.
STATEMENT OF ASSETS AND LIABILITIES
This statement details the fund's assets, liabilities, net assets and share
price for each share class 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 share price for each class is calculated by dividing net assets for
that class by the number of shares outstanding in that class as of the last day
of the reporting period.
STATEMENT OF OPERATIONS
This statement details 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.
STATEMENT OF CHANGES IN NET ASSETS
This statement demonstrates how the fund's net assets were affected by its
operating results, distributions to shareholders and shareholder transactions
(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 shares outstanding.
STATEMENT OF CASH FLOWS
The statement of cash flows reports net cash provided or used by operating,
investing and financing activities and the net effect of those flows on cash and
cash equivalents during the period.
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.
FINANCIAL HIGHLIGHTS
The financial highlights demonstrate how the fund's net asset value per share
was affected by the fund's operating results. The financial highlights table
also discloses the classes' performance and certain key ratios (e.g., class
expenses and net investment income as a percentage of average net assets).
7
<Page>
INVESTMENT PORTFOLIO
AUGUST 31, 2004 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - 84.0%
AEROSPACE/DEFENSE - 0.7%
CACI INTERNATIONAL, INC., Term Loan
3.63% 09/30/04 5,000 5,028
3.71% 11/09/04 5,000 5,028
3.95% 02/09/05 1,985,000 1,996,166
VOUGHT AIRCRAFT INDUSTRIES, INC.: Term Loan B 5.14% 06/30/07 1,290,459 1,303,364
Term Loan C 5.39% 06/30/08 2,138,264 2,159,647
Term Loan X 4.89% 12/31/06 847,637 855,054
----------------------------------------------------------------------------
AEROSPACE/ DEFENSE TOTAL 6,324,287
AIR TRANSPORT - 0.3%
UNITED AIRLINES, INC., Term Loan B 9.00% 09/30/04 2,973,557 3,007,010
----------------------------------------------------------------------------
AIR TRANSPORT TOTAL 3,007,010
AUTOMOTIVE - 4.0%
FEDERAL-MOGUL CORP.: Supplemental Revolver 5.39% 02/05/05 (b) 1,263,380 1,260,222
Term Loan B 4.14% 02/24/05 5,000,000 4,673,440
Term Loan C 5.39% 02/05/05 1,048,750 1,056,616
HLI OPERATING CO., INC., Term Loan
4.91% 09/28/04 267,006 272,513
5.39% 09/30/04 1,381,063 1,409,548
5.12% 10/29/04 910,351 929,127
5.42% 10/29/04 35,677 36,413
5.33% 11/29/04 920,709 939,698
5.73% 01/26/05 439,638 448,706
KEY AUTOMOTIVE GROUP: Term Loan B
4.49% 09/01/04 1,881,818 1,905,341
4.61% 09/29/04 1,986,364 2,011,194
4.78% 11/30/04 1,881,818 1,905,340
Term Loan C
7.27% 09/03/04 2,000,000 2,023,750
7.36% 09/29/04 2,250,000 2,276,719
7.53% 11/30/04 2,000,000 2,023,750
KEY PLASTICS LLC: Jr. Sec Sub Notes 18.32% 04/26/07 (c) 55,843 55,843
Sr. Sec Sub Notes 7.00% 04/26/07 (c) 101,433 101,433
KEYSTONE AUTOMOTIVE INDUSTRIES, INC., Term Loan
4.67% 09/17/04 482,609 489,019
6.00% 09/30/04 17,391 17,622
4.67% 02/17/05 452,174 458,179
MERIDIAN AUTOMOTIVE SYSTEMS, INC., 1st Lien Term Loan
6.09% 09/30/04 37,834 37,330
6.00% 10/28/04 5,462,166 5,389,339
SHILOH INDUSTRIES, INC., Term Loan B 5.64% 01/14/09 3,482,500 3,499,912
TRW AUTOMOTIVE ACQUISITIONS CORP., Term Loan D1 4.13% 02/28/11 2,498,087 2,543,365
----------------------------------------------------------------------------
AUTOMOTIVE TOTAL 35,764,419
</Table>
See accompanying Notes to Financial Statements
8
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
BEVERAGE & TOBACCO - 2.1%
BUFFETS, INC., Term Loan
4.98% 09/01/04 853,696 863,300
4.59% 09/30/04 2,513,043 2,541,315
Synthetic Letter of Credit 4.61% 06/28/09 466,600 471,849
CARIBBEAN RESTAURANT LLC, Tranche B 4.85% 06/30/09 3,000,000 3,041,250
COMMONWEALTH BRANDS, INC., Term Loan 5.69% 08/28/07 1,018,542 1,030,637
DR. PEPPER BOTTLING COMPANY OF TEXAS, Term Loan B
3.40% 09/22/04 5,626,233 5,690,406
3.40% 09/30/04 15,000 15,171
DS WATERS ENTERPRISES LP, Term Loan
4.34% 09/30/04 1,687,500 1,610,508
4.62% 12/30/04 750,000 715,781
SOUTHERN WINE & SPIRITS OF AMERICA, INC., Term Loan B 3.84% 07/02/08 2,940,081 2,975,915
----------------------------------------------------------------------------
BEVERAGE & TOBACCO TOTAL 18,956,132
BROADCAST RADIO & TELEVISION - 1.2%
FREEDOM COMMUNICATIONS, Term Loan B
3.34% 09/01/04 1,353,846 1,374,789
3.75% 11/29/04 646,154 656,149
GRAY TELEVISION, INC., Incremental Term Loan
3.36% 10/01/04 1,802,483 1,817,128
3.45% 11/03/04 277,305 279,558
GT BRANDS LLC, Term Loan 9.50% 09/30/07 2,654,829 2,389,347
SPANISH BROADCASTING SYSTEMS, INC., Term Loan 4.84% 10/30/09 4,353,125 4,423,863
----------------------------------------------------------------------------
BROADCASTING RADIO & TELEVISION TOTAL 10,940,834
BUILDING & DEVELOPMENT PRODUCTS - 0.6%
AIMCO PROPERTIES LP, Term Loan 4.70% 05/30/08 1,850,000 1,867,344
NATG HOLDINGS LLC: Credit Linked Certificate of Deposit 0.85% 01/23/05 1,039,745 805,803
Term Loan A 6.13% 01/23/09 963,853 204,518
Term Loan B1 6.63% 01/23/10 684,740 145,294
Term Loan B2 6.63% 01/23/10 72,363 58,614
TAPCO INTERNATIONAL CORP.: Term Loan B
4.33% 09/29/04 434,552 436,725
4.34% 09/30/04 1,075,517 1,080,894
Term Loan C
4.58% 09/29/04 417,120 419,206
4.59% 09/30/04 619,424 622,521
----------------------------------------------------------------------------
BUILDING & DEVELOPMENT PRODUCTS TOTAL 5,640,919
BUSINESS EQUIPMENT & SERVICES - 3.3%
BRICKMAN GROUP HOLDINGS, INC., Term Loan 6.78% 11/15/09 4,888,889 4,876,667
</Table>
See accompanying Notes to Financial Statements
9
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
BUSINESS EQUIPMENT & SERVICES - (CONTINUED)
HILLMAN GROUP, INC., Term Loan B
6.75% 09/30/04 4,375 4,424
4.63% 10/26/04 1,741,250 1,760,839
TRANSCORE HOLDINGS, INC.: Term Loan B
4.83% 09/30/04 2,632,000 2,664,900
6.25% 11/30/04 6,955 7,042
Term Loan C
4.83% 09/30/04 3,952,941 4,002,353
6.25% 11/30/04 17,059 17,272
URS CORP., Term Loan B 3.63% 08/22/08 1,324,391 1,331,428
WASHINGTON GROUP INTERNATIONAL, Credit Linked Certificate of Deposit 1.54% 10/03/07 9,600,000 9,648,000
XEROX CORP., Term Loan 3.34% 09/30/08 5,000,000 5,026,040
----------------------------------------------------------------------------
BUSINESS EQUIPMENT & SERVICES TOTAL 29,338,965
CABLE & SATELLITE TELEVISION - 9.3%
ATLANTIC BROADBAND FINANCE LLC, Term Loan B 4.61% 09/01/11 1,400,000 1,419,250
BRESNAN COMMUNICATIONS LLC, Term Loan B
4.83% 09/07/04 1,475,555 1,497,228
4.86% 09/07/04 368,889 374,307
5.09% 09/30/04 368,889 374,307
5.11% 10/15/04 1,936,667 1,965,113
CENTURY CABLE HOLDINGS LLC: Discretionary Term Loan 6.50% 12/31/09 3,500,000 3,413,228
Term Loan 6.50% 06/30/09 10,000,000 9,770,540
CHARTER COMMUNICATIONS OPERATING LLC, Tranche B Term Loan 4.92% 04/27/11 12,000,000 11,858,748
CSC HOLDINGS, INC., Revolver
2.56% 09/01/04 (b) 487,500 482,016
2.81% 09/01/04 (b) 29,167 28,839
2.75% 09/07/04 (b) 479,167 473,776
5.25% 09/30/04 (b) 5,000 4,944
3.06% 10/08/04 (b) 116,667 115,354
3.41% 11/08/04 (b) 486,666 481,191
HILTON HEAD COMMUNICATIONS LP, Revolver 4.50% 09/30/07 14,087,500 13,562,741
INSIGHT MIDWEST HOLDINGS LLC: Term Loan 3.94% 12/31/09 1,990,000 2,021,094
Term Loan A 3.25% 06/30/09 1,880,000 1,881,645
Term Loan B 3.94% 12/31/09 2,985,000 3,031,873
MEDIACOM COMMUNICATIONS CORP.: Term Loan A
3.24% 09/10/04 3,333,333 3,327,603
3.14% 09/30/04 666,667 665,521
Term Loan B
3.87% 09/08/04 960,000 967,425
3.97% 09/30/04 40,000 40,309
4.17% 12/08/04 1,000,000 1,007,734
</Table>
See accompanying Notes to Financial Statements
10
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
CABLE & SATELLITE TELEVISION - (CONTINUED)
OLYMPUS CABLE HOLDINGS LLC: Term Loan A 5.75% 06/30/10 9,500,000 9,225,174
Term Loan B 6.50% 09/30/10 1,000,000 977,500
UPC FINANCING PARTNERSHIP, Term Loan C2
7.33% 12/30/04 57,500 58,093
7.38% 01/07/05 11,385,000 11,502,413
WIDEOPENWEST FINANCE LLC, Incremental Term Loan B 6.10% 06/22/11 3,000,000 3,010,626
----------------------------------------------------------------------------
CABLE & SATELLITE TELEVISION TOTAL 83,538,592
CHEMICALS/PLASTICS - 5.4%
BRENNTAG AG, Term Loan B2 4.73% 12/09/11 2,500,000 2,532,812
CELANESE, Term Loan C
5.73% 04/06/11 3,000,000 3,063,126
Dollar Term Loan
3.98% 09/30/04 (b) 437,309 443,254
4.09% 09/30/04 (b) 1,184,961 1,201,069
4.10% 09/30/04 (b) 2,516,623 2,550,834
COFFEYVILLE, INC., Term Loan
6.63% 09/27/04 4,979,114 4,979,114
8.50% 09/30/04 20,886 20,886
GEORGIA GULF CORP., Term Loan D 3.69% 12/02/10 581,502 591,072
HUNTSMAN CO. LLC: Term Loan A 5.63% 03/31/07 6,245,821 6,278,168
Term Loan B
11.44% 09/16/04 968,418 973,433
11.44% 09/23/04 22,029 22,143
HUNTSMAN INTERNATIONAL LLC, Term B Dollar Loan 4.94% 12/31/10 4,000,000 4,060,000
KOSA BV: Tranche B-1 4.56% 04/29/11 3,297,059 3,317,665
Tranche B-2 4.56% 04/29/11 1,452,941 1,462,022
NALCO CO.: Term Loan A
4.07% 09/23/04 900,000 910,575
4.08% 09/23/04 763,782 772,757
4.43% 01/24/05 525,000 531,169
Term Loan B
4.08% 09/23/04 898,058 912,892
4.11% 09/23/04 628,341 638,720
4.43% 01/24/05 554,419 563,577
POLYPORE, INC., Term Loan 3.89% 11/12/11 2,000,000 2,016,250
RIPPLEWOOD HOLDINGS LLC, Term Loan 4.53% 06/21/11 6,000,000 6,060,000
WADDINGTON NORTH AMERICA, INC., Term Loan B 4.57% 04/07/11 4,455,000 4,445,257
----------------------------------------------------------------------------
CHEMICALS/ PLASTICS TOTAL 48,346,795
</Table>
See accompanying Notes to Financial Statements
11
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
CLOTHING/TEXTILES - 1.4%
LEVI STRAUSS & CO., Term Loan A
8.88% 09/30/04 32,292 35,144
8.88% 11/10/04 1,208,333 1,315,069
POLYMER GROUP, INC., Second Lien Term Loan 7.84% 04/27/11 3,000,000 3,011,250
First Lien Term Loan 4.84% 04/27/10 3,750,000 3,777,345
SPRINGS INDUSTRIES, INC., Term Loan B 5.59% 09/05/08 4,295,390 4,349,976
----------------------------------------------------------------------------
CLOTHING/TEXTILES TOTAL 12,488,784
CONGLOMERATE - 1.6%
APPLETON PAPERS, INC., Term Loan
3.79% 09/20/04 1,750,000 1,770,781
3.98% 11/19/04 1,750,000 1,770,781
JASON, INC., Term Loan B
5.89% 09/29/04 5,407 5,353
6.03% 11/29/04 2,070,792 2,050,084
LANGUAGE LINE LCC, Term Loan B 5.85% 06/13/11 3,000,000 3,031,875
MUELLER GROUP, INC., Term Loan
4.40% 09/30/04 2,132,110 2,142,770
4.93% 10/29/04 256,881 258,165
4.54% 11/30/04 256,881 258,166
YOUTH & FAMILY CENTERED SERVICES, INC., Term Loan B 7.25% 05/28/11 3,000,000 3,000,000
----------------------------------------------------------------------------
CONGLOMERATE TOTAL 14,287,975
CONTAINER/GLASS PRODUCTS - 2.4%
BAKER TANKS, INC., Term Loan
4.33% 09/13/04 16,500 16,639
4.34% 10/12/04 24,000 24,203
4.14% 11/10/04 600,000 605,063
4.69% 02/10/05 816,000 822,885
BERRY PLASTICS CORP., Term Loan Facility
4.07% 09/30/04 5,000 5,056
3.96% 11/09/04 1,995,000 2,017,444
CONSOLIDATED CONTAINER CO. LLC, Term Loan
4.69% 09/30/04 8,750 8,805
3.25% 12/31/04 8,750 8,804
5.13% 03/03/04 3,482,500 3,504,266
GRAPHIC PACKAGING INTERNATIONAL, INC., Term Loan B 4.35% 08/09/10 2,970,000 3,014,550
KERR GROUP, INC., Term Loan 5.09% 08/13/10 1,307,128 1,320,363
PRECISE TECHNOLOGY, INC., First Lien Term Loan 4.63% 03/31/11 1,995,000 2,008,093
REDDY ICE GROUP, INC., Term Loan 4.15% 08/17/09 744,375 754,455
</Table>
See accompanying Notes to Financial Statements
12
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
CONTAINER/GLASS PRODUCTS - (CONTINUED)
SOLA INTERNATIONAL, INC., Term Loan 4.09% 12/11/09 1,234,375 1,251,348
SOLO CUP, INC., Term Loan
4.09% 09/30/04 2,554,615 2,583,886
4.21% 11/01/04 3,415,385 3,454,518
----------------------------------------------------------------------------
CONTAINERS/GLASS PRODUCTS TOTAL 21,400,378
COSMETICS/TOILETRIES - 1.2%
AMERICAN SAFETY RAZOR CO., Tranche B
4.95% 10/29/04 20,000 20,250
4.84% 11/29/04 1,137,255 1,151,470
5.02% 11/29/04 837,745 848,217
CHURCH & DWIGHT CO., INC., Tranche B 3.27% 05/30/11 2,000,000 2,026,562
JOHNSON DIVERSEY, INC., Term Loan B
3.75% 09/03/04 128,849 131,056
3.95% 11/03/04 4,203,946 4,275,937
REVLON CONSUMER PRODUCTS CORP., Term Loan
7.60% 10/13/04 1,000,000 1,017,500
7.86% 01/11/05 1,000,000 1,017,500
----------------------------------------------------------------------------
COSMETICS/TOILETRIES TOTAL 10,488,492
ECOLOGICAL SERVICE & EQUIPMENT - 1.3%
ALLIED WASTE NORTH AMERICA, INC.: Term Loan D 4.10% 01/15/10 1,600,000 1,625,000
Tranche A 3.86% 01/15/10 4,757,143 4,829,689
ENVIRONMENTAL SYSTEMS PRODUCTS HOLDINGS, Second Lien
11.59% 09/30/04 2,083,333 2,151,041
11.68% 10/29/04 1,861,111 1,921,597
11.78% 11/30/04 555,556 573,612
SYNAGRO TECHNOLOGIES, INC., Term Loan
4.72% 11/17/04 790,280 794,231
6.25% 11/30/04 93,406 93,873
----------------------------------------------------------------------------
ECOLOGICAL SERVICES & EQUIPMENT TOTAL 11,989,043
ELECTRONIC/ELECTRIC - 2.3%
BRIDGE INFORMATION SYSTEMS, INC., Multidraw Term Loan 7.25% 07/07/03 (c)(d) 508,890 30,533
INVENSYS INTERNATIONAL HOLDINGS LTD., Term Loan B1 5.48% 09/05/09 3,492,730 3,540,755
ITRON, INC., Term Loan B 3.94% 06/28/11 1,000,000 1,010,000
SEAGATE TECHNOLOGY HOLDINGS, INC., Term Loan B 3.69% 05/31/07 3,920,000 3,973,410
SEMICONDUCTORS COMPONENTS INDUSTRIES LLC, Term Loan F 4.38% 08/04/09 1,709,739 1,725,055
TRANSFIRST HOLDINGS, INC., Term Loan C 9.20% 03/31/11 2,250,000 2,255,625
UGS CORP., Term Loan B 3.85% 05/27/11 1,500,000 1,511,250
</Table>
See accompanying Notes to Financial Statements
13
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
ELECTRONIC/ELECTRIC - (CONTINUED)
VERIFONE, INC., Second Lien Term Loan 7.68% 12/31/11 1,000,000 1,020,000
VIASYSTEMS, INC., Term Loan B 7.15% 09/30/08 5,711,567 5,766,301
----------------------------------------------------------------------------
ELECTRONIC/ ELECTRIC TOTAL 20,832,929
EQUIPMENT LEASING - 0.8%
NATIONAL EQUIPMENT SERVICE, Second Lien Term Loan 9.50% 08/17/10 1,500,000 1,507,500
UNITED RENTALS, INC., Delayed Draw Term Loan B
3.89% 09/30/04 4,666,667 4,720,917
4.03% 11/30/04 1,152,083 1,165,476
----------------------------------------------------------------------------
EQUIPMENT LEASING TOTAL 7,393,893
FARMING/AGRICULTURE - 0.5%
AGCO CORP., Term Loan
3.59% 09/30/04 832,500 837,964
3.59% 10/13/04 3,783,333 3,808,163
----------------------------------------------------------------------------
FARMING/ AGRICULTURE TOTAL 4,646,127
FINANCIAL INTERMEDIARIES - 0.7%
FINOVA GROUP, INC., Note 7.50% 11/15/09 (e) 1,901,856 960,437
MARINA DISTRICT FINANCE CO., INC., Term Loan A
3.41% 09/30/04 293,551 295,263
3.84% 09/30/04 267,516 269,076
3.89% 09/30/04 1,400,637 1,408,807
3.85% 10/04/04 735,669 739,960
3.90% 10/13/04 189,067 190,170
METRIS CO., Term Loan 10.99% 05/06/07 2,000,000 2,075,000
----------------------------------------------------------------------------
FINANCIAL INTERMEDIARIES TOTAL 5,938,713
FOOD PRODUCTS - 3.2%
AMERICAN SEAFOODS GROUP LLC, Term Loan B 4.89% 03/31/09 3,002,007 3,015,141
BURNS PHILP., INC., Delayed Draw Term Loan B 4.83% 02/20/09 1,975,000 2,002,156
INTERSTATE BRANDS CORP.: Term Loan C
5.09% 09/30/04 161,616 150,707
4.92% 02/14/04 1,797,980 1,676,616
Tranche A
5.23% 11/19/04 500,000 466,250
5.42% 02/25/05 1,375,000 1,282,187
LUIGINO'S, INC., Term Loan B
4.31% 09/01/04 2,571,429 2,597,144
4.69% 09/30/04 1,917,321 1,936,494
MERISANT CO., Term Loan B 4.43% 01/11/10 1,108,793 1,114,753
NELLSON NUTRACEUTICAL, Second Lien Term Loan 7.09% 04/02/10 3,000,000 2,880,000
</Table>
See accompanying Notes to Financial Statements
14
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
FOOD PRODUCTS - (CONTINUED)
PIERRE FOODS, INC., Term Loan B 3.98% 06/30/10 2,000,000 2,016,250
PINNACLE FOODS HOLDING CORP., Delayed Draw Term Loan
4.03% 09/30/04 18,000 18,225
4.20% 10/26/04 18,000 18,225
4.26% 10/26/04 7,146,000 7,235,325
SUNNY DELIGHT BEVERAGE CO., First Lien Term Loan 5.98% 08/20/10 2,000,000 2,020,000
----------------------------------------------------------------------------
FOOD PRODUCTS TOTAL 28,429,473
FOOD SERVICES - 0.7%
CARROLS CORP., Term Loan B 5.69% 12/31/07 1,291,218 1,303,727
DOMINO'S, INC., Term Loan 3.88% 06/25/10 2,115,161 2,151,185
JEAN COUTU GROUP, INC., Term Loan B 3.94% 07/30/11 2,500,000 2,524,432
----------------------------------------------------------------------------
FOOD SERVICES TOTAL 5,979,344
FOOD/DRUG RETAILERS - 1.1%
ATKINS NUTRITIONALS, INC., First Lien 4.84% 10/29/09 1,930,000 1,717,700
MICHAEL FOODS, INC.: Floater Term Loan 5.21% 11/20/11 3,000,000 3,088,125
Term Loan
3.96% 11/22/04 4,191,920 4,256,765
4.23% 11/22/04 353,535 359,004
4.24% 11/22/04 13,005 13,206
4.09% 11/26/04 404,040 410,290
----------------------------------------------------------------------------
FOOD/DRUG RETAILERS TOTAL 9,845,090
FOREST PRODUCTS - 0.7%
RLC INDUSTRIES CO., Term Loan B 6.02% 02/26/10 3,482,500 3,517,325
SP NEWSPRINT CO.: Term Loan 4.61% 01/08/10 1,051,667 1,066,127
Term B 1.58% 01/09/08 1,933,333 1,962,333
----------------------------------------------------------------------------
FOREST PRODUCTS TOTAL 6,545,785
HEALTH CARE - 5.4%
ALLIANCE IMAGING, INC: Term Loan A
3.25% 09/23/04 233,779 230,857
3.50% 05/24/05 949,427 937,559
Term Loan C
3.56% 09/20/04 325,732 324,511
3.94% 09/22/04 314,804 313,624
4.00% 09/23/04 353,052 351,728
4.00% 09/27/04 345,906 344,609
4.06% 10/25/04 382,052 380,619
AMERIPATH, INC., Term Loan 4.36% 03/27/10 3,220,000 3,244,150
</Table>
See accompanying Notes to Financial Statements
15
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
HEALTH CARE - (CONTINUED)
COLGATE MEDICAL LTD., Term Loan B
4.34% 09/28/04 795,455 804,155
4.34% 09/30/04 867,045 876,529
CONCENTRA OPERATING CORP., Term Loan
4.12% 09/30/04 8,086 8,128
4.26% 11/26/04 3,226,244 3,243,046
DADE BEHRING, INC., Term Loan B 3.88% 10/03/08 960,423 973,629
DAVITA, INC., Term Loan B
3.16% 09/30/04 435,448 439,841
3.59% 09/30/04 435,448 439,841
3.60% 10/15/04 259,241 261,857
3.74% 11/23/04 259,241 261,857
3.87% 12/31/04 435,448 439,841
3.98% 01/31/05 153,625 155,175
DJ ORTHOPEDICS LLC, Term Loan
3.88% 09/30/04 9,375 9,480
3.94% 10/29/04 196,875 199,090
4.25% 01/31/05 525,000 530,907
EDUCATE OPERATING CO. LLC, Term Loan 4.64% 03/31/11 997,500 1,009,345
EMPI CORP., Term Loan 4.70% 11/24/09 933,864 936,198
FHC HEALTH SYSTEMS: Delayed Draw Term Loan 9.31% 10/31/06 1,300,000 1,311,375
Initial Term Loan 7.31% 10/31/06 1,857,143 1,875,714
HANGER ORTHOPEDIC, Term Loan B 4.34% 09/30/09 2,562,873 2,566,076
HEALTHSOUTH CORP., Term Loan 10.38% 01/16/11 2,600,000 2,678,000
INSIGHT HEALTH SERVICES CORP., Term Loan B 5.09% 10/17/08 (f) 4,353,030 4,385,678
KINETIC CONCEPTS, INC., Term Loan B 3.59% 08/11/10 1,035,417 1,049,654
KNOWLEDGE LEARNING CORP., Term Loan B
4.78% 09/03/04 106,383 107,181
4.88% 09/27/04 808,511 814,575
4.89% 09/30/04 3,936,170 3,965,692
6.50% 09/30/04 42,220 42,536
MEDASSETS, INC.: Second Lien Term Loan 11.15% 06/16/08 500,000 507,500
Senior Term Loan
5.90% 09/30/04 832,015 838,255
6.35% 09/30/04 107,143 107,947
MEDPOINTE, INC., Term Loan B
6.85% 09/30/04 8,028 8,061
6.95% 11/05/04 3,114,962 3,127,618
MULTIPLAN, INC., Term Loan 4.34% 03/04/09 2,493,750 2,518,687
</Table>
See accompanying Notes to Financial Statements
16
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
HEALTH CARE - (CONTINUED)
PACIFICARE HEALTH SYSTEMS, INC., Term Loan
4.10% 09/13/04 404,167 409,892
4.14% 10/13/04 416,667 422,570
4.21% 11/15/04 416,667 422,570
QUINTILES TRANSNATIONAL CORP., Term Loan
5.84% 09/30/04 837,399 844,203
5.89% 09/30/04 403,226 406,502
SUNRISE MEDICAL HOLDINGS, INC., Term Loan B-1
4.81% 09/17/04 117,647 118,162
4.88% 09/30/04 1,058,824 1,063,456
4.94% 10/18/04 823,529 827,132
VWR INTERNATIONAL, INC., Term Loan B 4.11% 04/07/11 915,333 930,093
----------------------------------------------------------------------------
HEALTH CARE TOTAL 48,065,705
HOME FURNISHINGS - 1.3%
HOLMES GROUP, INC.: First Lien Term Loan
4.72% 09/13/04 1,500,000 1,492,500
4.85% 09/17/04 7,500 7,463
4.96% 11/19/04 1,492,500 1,485,037
Second Lien Term Loan
9.50% 09/12/04 1,058,824 1,053,530
9.50% 11/19/04 941,176 936,470
HOME INTERIORS & GIFTS, INC., Term Loan 5.41% 03/31/11 2,480,469 2,294,434
JARDEN CORP., Term Loan B 3.83% 04/24/08 1,240,625 1,249,154
SEALY MATTRESS CO., Term Loan C
4.06% 09/01/04 1,071,429 1,083,706
4.06% 09/08/04 1,794,642 1,815,205
----------------------------------------------------------------------------
HOME FURNISHINGS TOTAL 11,417,499
INDUSTRIAL EQUIPMENT - 0.6%
AXIA, INC., Term Loan B
5.68% 09/13/04 250,000 252,969
5.89% 09/30/04 16,667 16,865
5.93% 11/12/04 233,333 236,104
5.99% 12/13/04 458,333 463,775
COPPERWELD CORP., Term Loan 6.12% 12/16/11 1,215,444 1,154,672
DRESSER, INC., Term Loan C 4.15% 04/10/09 1,127,228 1,144,313
FLOWSERVE CORP., Term Loan C
4.06% 09/01/04 71,429 72,411
4.25% 09/13/04 428,571 434,463
4.44% 09/30/04 34,961 35,442
4.38% 10/05/04 31,429 31,861
</Table>
See accompanying Notes to Financial Statements
17
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
INDUSTRIAL EQUIPMENT - (CONTINUED)
TEREX CORP., Term Loan
3.16% 09/30/04 676,366 685,667
3.34% 10/29/04 676,366 685,666
3.78% 11/30/04 258,707 262,264
----------------------------------------------------------------------------
INDUSTRIAL EQUIPMENT TOTAL 5,476,472
INSURANCE - 1.1%
CONSECO, INC., Term Loan 5.11% 06/22/10 10,000,000 10,152,080
----------------------------------------------------------------------------
INSURANCE TOTAL 10,152,080
LEISURE GOODS/ACTIVITIES/MOVIES - 3.4%
AMF BOWLING WORLDWIDE, INC., Term Loan B
4.15% 09/29/04 1,425,926 1,438,849
4.58% 09/30/04 2,037,037 2,055,499
6.50% 09/30/04 122,222 123,330
4.67% 10/29/04 1,208,472 1,219,424
4.76% 11/26/04 692,593 698,870
AMSCAN HOLDINGS, INC., Term Loan
4.35% 09/14/04 1,360,976 1,377,988
4.35% 10/14/04 292,683 296,342
4.59% 01/14/05 1,346,341 1,363,170
CARMIKE CINEMAS, INC., Sr. Secured 2nd Priority Term Loan 4.41% 02/02/09 4,643,333 4,771,025
CINEMARK USA, INC., Tranche C Term Loan
3.56% 09/09/04 6,250 6,297
3.38% 11/08/04 2,487,500 2,506,156
CNL HOSPITALITY PARTNERS LP, Term Loan 4.31% 01/02/05 2,640,845 2,640,845
METRO-GOLDWYN-MAYER STUDIOS, INC., Term Loan B 4.14% 04/30/11 2,000,000 2,009,750
REGAL CINEMAS, INC., Term Loan 3.88% 11/10/10 5,803,182 5,875,722
SIX FLAGS THEME PARKS, INC., Term Loan B 4.04% 06/30/09 1,584,525 1,592,943
WARNER MUSIC GROUP, Term Loan B
4.03% 10/22/04 750,000 760,715
4.53% 11/24/04 742,500 753,107
4.32% 11/30/04 1,492,500 1,513,822
----------------------------------------------------------------------------
LEISURE GOODS/ ACTIVITIES/ MOVIES TOTAL 31,003,854
LODGING & CASINOS - 3.5%
OPBIZ Term Loan A 4.80% 08/31/10 (c) 7,240,655 7,130,043
Term Loan B 5.97% 08/31/10 (c) 16,747 16,491
ALLIANCE GAMING CORP., Term Loan B 3.79% 09/04/09 4,530,121 4,590,521
AMERISTAR CASINOS, INC., Term Loan B 3.56% 12/20/06 787,505 798,087
EXTENDED STAY AMERICA, INC., Junior Floating Rate Note 3.88% 05/14/16 (c) 5,000,000 5,007,000
</Table>
See accompanying Notes to Financial Statements
18
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
LODGING & CASINOS - (CONTINUED)
GREEN VALLEY RANCH GAMING LLC, Term Loan B 4.34% 12/22/10 3,980,000 4,039,700
STRATEGIC HOTEL CAPITAL Term Loan B2 4.38% 07/09/06 5,000,000 5,000,000
WYNDHAM INTERNATIONAL, INC., Term Loan I 6.38% 06/30/06 4,914,269 4,814,961
----------------------------------------------------------------------------
LODGING & CASINOS TOTAL 31,396,803
OIL/GAS - 2.5%
ALON USA, Term Loan 10.00% 12/12/08 5,000,000 5,150,000
ATP OIL & GAS CORP., 1st Lien Term Loan
10.50% 09/15/04 661,667 678,209
10.50% 09/30/04 666,667 683,334
10.50% 10/29/04 333,333 341,666
10.50% 01/31/05 333,333 341,666
BELDEN & BLAKE CORP., Term Loan 6.25% 06/30/11 3,000,000 3,028,125
LA GRANGE ACQUISITION LP, Term Loan
4.48% 09/03/04 551,724 560,000
4.64% 09/30/04 448,276 455,000
MAGELLAN MIDSTREAM HOLDINGS LP, Tranche B 4.65% 06/17/08 952,061 966,342
SECUNDA INTERNATIONAL LTD., Floating Rate Note 9.76% 09/01/12 2,000,000 1,990,000
TESORO PETROLEUM CORP., Fixed Asset Term Loan 7.10% 04/15/08 3,160,000 3,257,764
TRANSWESTERN PIPELINE CO., Term Loan B
3.82% 09/09/04 7,500 7,569
3.88% 10/08/04 2,992,500 3,019,932
WESTERN REFINING CO. LP, Term Loan B 5.14% 08/28/08 1,440,000 1,461,600
----------------------------------------------------------------------------
OIL/GAS TOTAL 21,941,207
PUBLISHING - 2.2%
ADAMS OUTDOOR ADVERTISING LP, First Lien Term Loan 3.88% 10/15/11 1,500,000 1,518,125
DEX MEDIA EAST LLC: Term Loan A
3.57% 09/09/04 1,058,722 1,071,514
3.58% 09/13/04 781,204 790,643
3.60% 09/20/04 727,613 736,405
3.59% 09/30/04 1,058,722 1,071,514
3.71% 11/08/04 1,323,402 1,339,393
3.76% 11/26/04 859,953 870,344
3.79% 11/30/04 1,078,134 1,091,161
Term Loan B
3.57% 09/09/04 83,805 84,975
3.58% 09/13/04 71,440 72,437
3.60% 09/20/04 83,851 85,021
3.59% 09/30/04 119,721 121,392
3.71% 11/08/04 646,495 655,519
3.76% 11/26/04 107,796 109,301
3.79% 11/30/04 123,392 125,114
</Table>
See accompanying Notes to Financial Statements
19
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
PUBLISHING - (CONTINUED)
DEX MEDIA WEST LLC, Term Loan A
3.57% 09/09/04 461,990 468,150
3.58% 09/13/04 214,197 217,053
3.54% 09/20/04 283,494 287,274
3.59% 09/30/04 590,613 598,488
3.58% 10/08/04 343,868 348,453
3.70% 10/26/04 973,855 986,840
3.68% 11/12/04 188,996 191,515
3.73% 11/19/04 322,868 327,173
3.79% 11/30/04 584,838 592,635
DIMAC HOLDINGS, INC.: Term Loan A 15.00% 12/31/05 (d) 246,193 923
Term Loan B 15.00% 09/30/02 (d) 65,687 1,971
DIMAC MARKETING PARTNERS, INC.: Revolver 7.50% 07/01/03 (d) 27,443 --
Term Loan B 7.50% 01/01/05 (d) 159,403 4,782
RELIZON CO., Term Loan 4.73% 02/20/11 1,793,333 1,803,421
SUN MEDIA CORP, Term Loan B
3.83% 09/24/04 65,217 65,910
3.93% 10/29/04 1,281,848 1,295,468
TRANSWESTERN PUBLISHING CO., First Lien Term Loan
3.38% 09/30/04 812,500 819,356
3.88% 09/30/04 325,000 327,742
3.94% 04/26/05 1,250,000 1,260,548
----------------------------------------------------------------------------
PUBLISHING TOTAL 19,340,560
RAIL INDUSTRIES - 0.2%
RAILAMERICA TRANSPORTATION CORP., Term Loan 4.25% 05/22/09 1,347,618 1,367,664
----------------------------------------------------------------------------
RAIL INDUSTRIES TOTAL 1,367,664
RETAILERS - 0.4%
CH OPERATING LLC, Term Loan
6.19% 09/30/04 206,897 207,414
6.19% 10/29/04 1,137,931 1,140,776
PRESTIGE BRANDS HOLDINGS, INC., Tranche B
6.25% 09/30/04 6,268 6,289
4.08% 10/26/04 1,988,732 1,995,360
----------------------------------------------------------------------------
RETAILERS TOTAL 3,349,839
STEEL - 0.7%
AMSTED INDUSTRIES, INC., Term Loan
5.59% 09/30/04 668,382 683,003
5.60% 09/30/04 176,471 180,331
5.71% 11/01/04 2,867,647 2,930,377
THE TECHS INDUSTRIES, INC., Term Loan 3.89% 01/14/10 2,962,500 2,969,906
----------------------------------------------------------------------------
STEEL TOTAL 6,763,617
</Table>
See accompanying Notes to Financial Statements
20
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
SURFACE TRANSPORT - 2.9%
AMERICAN COMMERCIAL LINES LLC: Term Loan A 5.50% 06/30/05 673,286 664,449
Term Loan B 6.25% 06/30/06 1,026,863 1,014,027
Term Loan C 6.50% 06/30/07 1,816,231 1,793,528
COMCAR INDUSTRIES, INC., Term Loan B
6.61% 09/20/04 4,750,000 4,726,250
6.62% 09/24/04 200,000 199,000
8.00% 11/01/04 25,000 24,875
HELM HOLDING CORP., Term Loan B 4.56% 07/02/10 5,000,000 5,064,585
LAIDLAW INVESTMENTS LTD., Term Loan B 5.50% 06/19/09 4,370,000 4,443,744
PACER INTERNATIONAL, INC., Term Loan
4.06% 09/15/04 39,216 39,780
4.19% 09/16/04 47,059 47,735
4.06% 11/12/04 286,216 290,330
4.44% 12/15/04 113,784 115,420
4.06% 04/14/04 215,686 218,786
TRANSPORT INDUSTRIES LP Term Loan B 5.56% 06/13/10 3,000,000 3,005,625
TTI, INC., Term Loan
5.40% 09/30/04 28,696 28,935
4.99% 10/18/04 846,522 853,576
5.36% 10/18/04 770,657 777,079
UNITED STATES SHIPPING LLC, Term Loan
3.84% 09/30/04 21,605 21,835
4.12% 12/31/04 956,790 966,956
YELLOW ROADWAY CORP.: Credit Linked Certificate of Deposit 1.50% 06/11/08 1,456,364 1,469,563
Initial Term Loan 5.25% 06/11/08 520,130 524,844
----------------------------------------------------------------------------
SURFACE TRANSPORT TOTAL 26,290,922
TELECOMMUNICATIONS/CELLULAR - 4.2%
AIRGATE PCS, INC.: Tranche 1
5.44% 09/30/04 19,089 19,041
5.38% 11/30/04 545,045 543,683
Tranche 2
5.44% 09/30/04 171,502 171,073
5.13% 10/25/04 292,502 291,771
5.56% 11/29/04 273,221 272,538
5.63% 12/15/04 175,501 175,063
5.63% 12/31/04 175,501 175,062
5.75% 01/04/05 877,506 875,312
5.75% 02/09/05 526,504 525,188
5.75% 02/28/05 4,812,315 4,800,284
CELLULAR SOUTH, INC., Term Loan
4.16% 10/27/04 1,062,857 1,076,143
4.38% 02/11/05 1,937,143 1,961,357
</Table>
See accompanying Notes to Financial Statements
21
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
TELECOMMUNICATIONS/CELLULAR - (CONTINUED)
CONSOLIDATED COMMUNICATIONS, INC., Term Loan B
4.34% 09/30/04 1,000,000 1,013,750
4.35% 09/30/04 1,357,143 1,375,804
4.48% 11/19/04 2,142,857 2,172,321
MICROCELL SOLUTIONS, INC., Tranche B Term Loan A 5.59% 03/17/11 3,209,375 3,226,760
NEXTEL PARTNERS, Term Loan C 3.81% 05/31/11 5,000,000 5,070,625
QWEST CORP., Term Loan B 6.95% 06/30/10 10,000,000 9,718,750
US UNWIRED, INC., Floating Rate Note 5.79% 06/15/10 (c) 4,000,000 4,060,000
----------------------------------------------------------------------------
TELECOMMUNICATIONS/ CELLULAR TOTAL 37,524,525
TELECOMMUNICATIONS/COMBINATION - 2.7%
ALASKA COMMUNICATIONS SYSTEMS HOLDINGS, INC., Term Loan 4.88% 02/14/09 1,741,250 1,759,025
CENTENNIAL CELLULAR OPERATING CO., Term Loan B
3.91% 09/30/04 (b) 3,822,500 3,835,940
4.33% 11/30/04 (b) 173,750 174,361
4.53% 11/30/04 (b) 152,900 153,437
NEXTEL FINANCE CO., INC., Term Loan E 3.81% 12/15/10 14,601,413 14,694,921
SBA SENIOR FINANCE, INC., Term Loan
4.65% 09/17/04 (b) 3,807,692 3,841,603
5.37% 12/30/04 (b) 207,693 209,543
----------------------------------------------------------------------------
TELECOMMUNICATIONS/ COMBINATION TOTAL 24,668,830
TELECOMMUNICATIONS/WIRELESS - 1.1%
DOBSON CELLULAR SYSTEMS, INC.: Revolver 5.10% 10/21/09 (b) 233,333 223,417
Term Loan
5.10% 09/20/04 4,281,203 4,279,597
5.17% 10/20/04 3,544,672 3,543,343
SPECTRASITE COMMUNICATIONS, INC., Incremental Term Loan 3.93% 12/31/07 1,678,299 1,703,474
----------------------------------------------------------------------------
TELECOMMUNICATION/WIRELESS TOTAL 9,749,831
TELECOMMUNICATIONS WIRELINE - 0.5%
VALOR TELECOMMUNICATIONS ENTERPRISES LLC, Term Loan B
5.33% 09/10/04 2,195,809 2,209,532
5.39% 09/30/04 2,465,588 2,480,998
----------------------------------------------------------------------------
TELECOMMUNICATIONS WIRELINE TOTAL 4,690,530
UTILITIES - 6.5%
ALLEGHENY ENERGY SUPPLY CO., Term Loan B
4.58% 09/30/04 192,500 195,556
4.39% 11/10/04 2,300,000 2,336,513
4.94% 02/07/05 500,000 507,937
AQUILA, INC., Term Loan 8.00% 05/15/06 3,412,698 3,535,344
</Table>
See accompanying Notes to Financial Statements
22
<Page>
<Table>
<Caption>
PAR ($) VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
VARIABLE RATE SENIOR LOAN INTERESTS (a) - (CONTINUED)
UTILITIES - (CONTINUED)
ASTORIA ENERGY LLC, 1st Lien Term Loan
6.84% 09/30/04 2,418,164 2,456,451
6.86% 04/18/05 4,581,836 4,654,380
CALPINE CONSTRUCTION FINANCE CO. LP, Floating Rate Note 9.75% 08/26/11 (c) 2,000,000 2,165,000
CALPINE CORP., Second Lien 7.35% 07/16/07 6,633,000 5,638,050
CENTERPOINT ENERGY, INC., Term Loan 4.72% 10/07/06 6,954,025 6,987,925
INFRASOURCE, INC., Term Loan 4.59% 09/30/10 1,963,776 1,949,048
MIDWEST GENERATIONS LLC, Term Loan
4.85% 10/01/04 742,500 752,709
4.89% 10/01/04 750,000 760,313
4.57% 10/27/04 1,500,000 1,520,625
MISSION ENERGY HOLDINGS CO.: Term Loan
7.00% 09/01/04 875,000 879,375
7.00% 12/10/04 875,000 879,375
Term Loan B 9.11% 07/02/06 9,253,246 9,739,042
NORTHWESTERN CORP., Term Loan 7.10% 12/01/06 2,462,500 2,493,281
NRG ENERGY, INC.: Credit Linked Certificate of Deposit 5.50% 06/23/10 833,333 861,458
Term Loan 5.56% 06/23/10 1,476,725 1,526,934
RIVERSIDE ENERGY CENTER LLC, Term Loan 6.02% 06/24/11 2,785,336 2,813,190
ROCKY MOUNTAIN ENERGY CENTER LLC: Credit-Linked Deposit 6.02% 06/24/11 212,396 214,520
Term Loan 6.02% 06/24/11 2,002,268 2,022,290
TNP ENTERPRISES, INC., Term Loan 6.73% 12/31/06 2,970,000 3,025,688
----------------------------------------------------------------------------
UTILITIES TOTAL 57,915,004
TOTAL VARIABLE RATE SENIOR LOAN INTERESTS
(COST OF $752,301,491) 753,238,921
SENIOR NOTES - 0.1%
TELECOMMUNICATIONS/WIRELESS - 0.1%
CRICKET COMMUNICATIONS, INC., Senior Secured Note 1.00% 08/16/10 460,200 493,565
----------------------------------------------------------------------------
TELECOMMUNICATION/WIRELESS TOTAL 493,565
TOTAL SENIOR NOTES
(COST OF $0) 493,565
</Table>
See accompanying Notes to Financial Statements
23
<Page>
<Table>
<Caption>
SHARES VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
COMMON STOCKS (g) - 0.6%
BUSINESS SERVICES - 0.2%
Leap Wireless International, Inc. 76,137 2,105,188
Enviroment Systems Products (c) 3,445 --
NATG Holdings LLC (c) 322,876 --
----------------------------------------------------------------------------
BUSINESS SERVICES TOTAL 2,105,188
DIVERSIFIED MANUFACTURING - 0.1%
Gentek, Inc. 4,015 155,581
Superior Telecom, Inc. 47,459 630,730
----------------------------------------------------------------------------
DIVERSIFIED MANUFACTURING TOTAL 786,311
HEALTHCARE - 0.2%
Sun Healthcare Group, Inc. 172,853 1,486,536
----------------------------------------------------------------------------
HEALTHCARE TOTAL 1,486,536
INDUSTRIAL EQUIPMENT -0.1%
Copperweld Corp., Class A (c) 56 939,400
Copperweld Corp., Class B (c) 400 232,000
----------------------------------------------------------------------------
INDUSTRIAL EQUIPMENT TOTAL 1,171,400
TOTAL COMMON STOCKS
(COST OF $6,043,000) 5,549,435
<Caption>
UNITS
----------------------------------------------------------------------------
PREFERRED STOCKS - 0.0%
DIVERSIFIED MANUFACTURING - 0.0%
Dimac Holdings (c) 486 --
Key Plastics LLC (c) 13 --
Superior Telecom, Inc. (c) 14,382 14,382
----------------------------------------------------------------------------
DIVERSIFIED MANUFACTURING TOTAL 14,382
TOTAL PREFERRED STOCKS
(COST OF $14,382) 14,382
</Table>
See accompanying Notes to Financial Statements
24
<Page>
<Table>
<Caption>
SHARES VALUE ($)
- ------------------------------------------ ----------------------------------------------------------------------------
WARRANTS - 0.0% UNITS
DIVERSIFIED MANUFACTURING - 0.0%
Dimac Holdings (c) 483 --
Gentek, Inc., Class A, expires 10/31/06 4 31
Gentek, Inc., Class B, expires 10/31/08 2 10
----------------------------------------------------------------------------
DIVERSIFIED MANUFACTURING TOTAL 41
TOTAL WARRANTS
(COST OF $41) 41
<Caption>
PAR ($)
----------------------------------------------------------------------------
SHORT-TERM OBLIGATION - 14.5%
Repurchase agreement with State Street
Bank & Trust Co., dated 08/31/04 due
09/01/04 at 1.490%, collateralized by a
U.S. Treasury Note maturing 03/15/09,
market value of $132,883,851
(repurchase proceeds $130,272,392)
(cost of $130,267,000) 130,267,000 130,267,000
TOTAL INVESTMENTS - 99.2%
(COST OF $888,625,914)(h) 889,563,344
OTHER ASSETS & LIABILITIES, NET - 0.8% 6,807,152
NET ASSETS - 100.0% 896,370,496
</Table>
NOTES TO INVESTMENT PORTFOLIO:
(a) Senior Loans in which the Fund invests generally pay interest at rates
which are periodically redetermined by reference to a base lending rate
plus a premium. 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 Inter-Bank Offered
Rate ("LIBOR") and (iii) the certificate of deposit rate. Senior loans are
generally considered to be restricted in that the Fund ordinarily is
contractually obligated to receive approval from the Agent Bank and/or
borrower prior to the disposition of a Senior Loan.
(b) Additional unfunded commitment, see note 8.
(c) Represents fair value as determined in good faith under the direction of
the Board of Trustees.
(d) These issuers are in default of certain debt covenants. Income is not being
accrued. As of August 31, 2004, the value of these securities amounted to
$38,209, which amounted to less than 0.01% of net assets.
(e) Issued as part of bankruptcy reorganization
(f) Loans held on participation.
(g) Non-income producing security.
(h) Cost for federal income tax purposes is $888,968,895.
See accompanying Notes to Financial Statements
25
<Page>
STATEMENT OF ASSETS AND LIABILITIES
AUGUST 31, 2004
HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
<Table>
<Caption>
($)
- ------------------------------------------ ---------------------------------------------------------------------------------
ASSETS Investments, at cost (including repurchase agreement) 888,625,914
----------------
Investments, at value 759,296,344
Repurchase agreement, at value 130,267,000
Cash 462
Receivable for:
Investments sold 3,665,866
Interest and fees 4,071,678
Deferred Trustees' compensation plan 1,906
Other assets 5,731
----------------
Total Assets 897,308,987
LIABILITIES Deferred facility fees 444,906
Payable for:
Investment advisory fee 323,109
Transfer agent fee 500
Pricing and bookkeeping fees 62,333
Trustees' fees 272
Audit fee 60,290
Custody fee 6,000
Deferred Trustees' fees 1,906
Other liabilities 39,175
----------------
Total Liabilities 938,491
NET ASSETS 896,370,496
</Table>
See Accompanying Notes to Financial Statements
26
<Page>
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED AUGUST 31, 2004
HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
<Table>
<Caption>
($)
- ------------------------------------------ ---------------------------------------------------------------------------------
INVESTMENT INCOME Interest 34,444,565
Dividends 650
Facility and other fees 1,950,287
----------------
Total Investment Income 36,395,502
EXPENSES Investment advisory fee 3,283,463
Transfer agent fee 6,000
Pricing and bookkeeping fees 221,436
Trustees' fees 10,023
Custody fee 34,245
Other expenses 262,293
----------------
Total Operating Expenses 3,817,460
----------------
Interest expense 22,153
Total expenses 3,839,613
----------------
Custody earnings credit (1,144)
----------------
Net Expenses 3,838,469
----------------
Net Investment Income 32,557,033
NET REALIZED AND UNREALIZED GAIN (LOSS) ON Net realized gain on investments 12,489,394
PORTFOLIO POSITIONS Net change in unrealized
appreciation/depreciation
on investments
20,295,744
----------------
Net Gain 32,785,138
----------------
Net Increase in Net Assets
from Operations 65,342,171
</Table>
See Accompanying Notes to Financial Statements
27
<Page>
STATEMENT OF CHANGES IN NET ASSETS
HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
<Table>
<Caption>
INCREASE (DECREASE) IN NET ASSETS: YEAR ENDED AUGUST 31 2004 ($) 2003 ($)
- ------------------------------------------ ---------------------------------------------------------------------------------
OPERATIONS Net investment income 32,557,033 27,411,344
Net realized gain (loss) on investments 12,489,394 (11,578,981)
Net realized loss on the disposal of investments
in violation of restrictions and subsequently
reimbursed by affiliate -- --
Net change in unrealized appreciation/depreciation
on investments 20,295,744 33,906,354
------------ -------------
Net Increase from Operations 65,342,171 49,738,717
TRANSACTIONS IN INVESTORS' BENEFICIAL Contributions 453,429,815 93,827,932
INTEREST Withdrawals (133,062,921) (169,392,880)
------------ -------------
Net Increase (Decrease) from Transactions in
Investors' Beneficial Interest 320,366,894 (75,564,948)
------------ -------------
Total Increase (Decrease) in Net Assets 385,709,065 (25,826,231)
NET ASSETS Beginning of period 510,661,431 536,487,662
------------ -------------
End of period 896,370,496 510,661,431
</Table>
See Accompanying Notes to Financial Statements
28
<Page>
STATEMENT OF CASH FLOWS
AUGUST 31, 2004
HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
<Table>
<Caption>
FOR THE
YEAR ENDED
INCREASE (DECREASE) IN CASH AUGUST 31, 2004 ($)
- ---------------------------------------------- ----------------------------------------------------------------------------
CASH FLOWS USED FOR OPERATING ACTIVITIES Net investment income 32,557,033
ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME Purchase of investment securities (891,194,827)
TO NET CASH USED FOR OPERATING ACTIVITIES Proceeds from disposition of investment securities 612,433,161
Purchase of short-term portfolio investments, net (68,488,000)
Increase in interest and fees receivable (1,339,974)
Increase in receivable for investments sold (2,388,043)
Increase in other assets (1,795)
Increase in deferred facility fees 234,362
Increase in payable for accrued expenses 127,732
Net amortization of premium (discount) (2,161,401)
Decrease in payable of investments purchased (18,333)
Decrease in other liabilities (125,491)
------------
Net cash used for operating activities (320,365,576)
CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from capital contributions 453,429,815
Payment of capital withdrawals (133,062,921)
------------
Net cash flows from financing activities 320,366,894
------------
Net increase in cash 1,318
CASH Cash (bank overdraft) at beginning of year (856)
------------
Cash at end of year 462
</Table>
See Accompanying Notes to Financial Statements
29
<Page>
STATEMENT OF ASSETS AND LIABILITIES
AUGUST 31, 2004
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
<Table>
<Caption>
($)
- ------------------------------------------ ---------------------------------------------------------------------------------
ASSETS Investment in Portfolio, at cost 66,001,856
----------------
Investment in Portfolio, at value 66,103,606
Expense reimbursement due from Investment Advisor 19,796
Deferred Trustees' compensation plan 3,461
----------------
Total Assets 66,126,863
LIABILITIES Payable for:
Distributions 31,165
Administration fee 11,171
Transfer agent fee 2,643
Pricing and bookkeeping fees 2,562
Trustees' fees 930
Audit fee 15,140
Custody fee 500
Reports to shareholders 17,000
Deferred Trustees' fees 3,461
Other liabilities 8,189
----------------
Total Liabilities 92,761
NET ASSETS 66,034,102
COMPOSITION OF NET ASSETS Paid-in capital 73,439,417
Overdistributed net investment income (27,972)
Accumulated net realized loss allocated from Portfolio (7,479,093)
Net unrealized appreciation on investments
allocated from Portfolio 101,750
----------------
NET ASSETS 66,034,102
Shares outstanding (unlimited number authorized) 6,747,447
Net asset value per share 9.79
</Table>
See Accompanying Notes to Financial Statements
30
<Page>
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED AUGUST 31, 2004
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
<Table>
<Caption>
($)
- ------------------------------------------ ---------------------------------------------------------------------------------
INVESTMENT INCOME Interest, dividends and fees allocated from Portfolio 4,178,300
EXPENSES Net operating expenses allocated from Portfolio 431,001
Administration fee 165,949
Transfer agent fee 16,638
Pricing and bookkeeping fees 25,580
Trustees' fees 15,359
Custody fee 2,871
Other expenses 83,637
----------------
Total Operating Expenses 741,035
Interest expense allocated from Portfolio 2,659
----------------
Total Expense 743,694
----------------
Fees and expenses waived or reimbursed
by investment advisor (120,739)
----------------
Net Expenses 622,955
----------------
Net Investment Income 3,555,345
NET REALIZED AND UNREALIZED GAIN (LOSS) ON Net realized gain on investments
INVESTMENTS ALLOCATED FROM PORTFOLIO allocated from Portfolio 772,663
Net change in unrealized
appreciation/depreciation on
investments allocated from Portfolio 3,878,586
----------------
Net Gain 4,651,249
----------------
Net Increase in Net Assets
from Operations 8,206,594
</Table>
See Accompanying Notes to Financial Statements
31
<Page>
STATEMENT OF CHANGES IN NET ASSETS
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
<Table>
<Caption>
INCREASE (DECREASE) IN NET ASSETS: YEAR ENDED AUGUST 31 2004 ($) 2003 ($)
- ------------------------------------------ ---------------------------------------------------------------------------------
OPERATIONS Net investment income 3,555,345 5,385,567
Net realized gain (loss) on investments
allocated from Portfolio 772,663 (2,409,848)
Net realized loss on the disposal of
investments in violation of restrictions
and subsequently reimbursed by affiliate
allocated from Portfolio -- --
Net change in unrealized appreciation/depreciation
on investments allocated from Portfolio 3,878,586 6,893,031
----------- -----------
Net Increase from Operations 8,206,594 9,868,750
DISTRIBUTIONS DECLARED TO SHAREHOLDERS From net investment income (3,568,779) (5,397,399)
SHARE TRANSACTIONS Subscriptions 1,300,003 --
Distributions reinvested 3,199,887 5,469,970
Redemptions (32,809,314) (21,147,179)
----------- -----------
Net Decrease from Share Transactions (28,309,424) (15,677,209)
----------- -----------
Total Decrease in Net Assets (23,671,609) (11,205,858)
NET ASSETS Beginning of period 89,705,711 100,911,569
End of period (including overdistributed net
investment income of $(27,972) and $(28,666),
respectively) 66,034,102 89,705,711
CHANGES IN SHARES Subscriptions 134,996 --
Issued for distributions reinvested 330,554 616,460
Redemptions (3,389,936) (2,392,797)
----------- -----------
Net Decrease (2,924,386) (1,776,337)
</Table>
See Accompanying Notes to Financial Statements
32
<Page>
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2004
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
NOTE 1. ORGANIZATION
Highland Institutional Floating Rate Income Fund (the "Fund") formerly Columbia
Institutional Floating Rate Income Fund, is a Massachusetts business trust
registered under the Investment Company Act of 1940, as amended, as a
non-diversified, closed-end management investment company.
Effective October 13, 2003, the Fund changed its name from Stein Roe
Institutional Floating Rate Income Fund to Columbia Institutional Floating Rate
Income Fund. Also on that date, the Portfolio changed its name from Stein Roe
Floating Rate Limited Liability Company to Columbia Floating Rate Limited
Liability Company.
Effective October 18, 2004, the Columbia Institutional Floating Rate Income Fund
was renamed Highland Institutional Floating Rate Income Fund. Also on that date,
the Columbia Floating Rate Limited Liability Company was renamed Highland
Floating Rate Limited Liability Company.
INVESTMENT GOAL
The Fund invests all of its investable assets in Highland Floating Rate Limited
Liability Company (the "Portfolio") formerly Columbia Floating Rate Limited
Liability Company. The Portfolio seeks a high level of current income consistent
with preservation of capital.
THE PORTFOLIO
The Portfolio is a non-diversified, closed-end management investment company
organized as a Delaware limited liability company. The Portfolio allocates
income, expenses, realized and unrealized gains and losses to each investor on a
daily basis, based on methods in compliance with the Internal Revenue Code. At
August 31, 2004, the Fund and the Columbia Floating Rate Fund owned 7.4% and
92.6%, respectively, of the Portfolio.
FUND SHARES
The Fund may issue an unlimited number of shares, which are offered continuously
at net asset value.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America ("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 Portfolio and the Fund in the preparation of their financial statements.
SECURITY VALUATION
The value of the Portfolio is determined in accordance with guidelines
established and periodically reviewed by the Board of Trustees. Senior loans are
generally valued using market prices or quotations provided by banks, dealers or
pricing services with respect to secondary market transactions. The prices
provided by these principal market makers may differ from the value that would
be realized if the loans were sold and the difference could be material to the
financial statements. In the absence of actual market values, the senior loans
will be valued at fair value, which is intended to approximate market value,
pursuant to procedures approved by the Board of Trustees. In determining fair
value, the following factors, among others, will be considered on an on-going
basis: (i) the creditworthiness of the Borrower; (ii) the current interest rate,
the interest rate redetermination period and maturity of such senior loan
interests; and (iii) recent prices in the market for instruments of similar
quality, rate and interest rate redeterminiation period and maturity. Because of
uncertainty inherent in the valuation process, the estimated value of a senior
loan may differ significantly from the value that would have been used had there
been market activity for that senior loan interest.
Equity securities are valued at the last sale price on the principal exchange on
which they trade, except for securities traded on the NASDAQ, which are valued
at the NASDAQ official close price. Unlisted securities or listed securities for
which there were no sales during
33
<Page>
the day are valued at the closing bid price on such exchanges or
over-the-counter markets.
Short-term debt obligations maturing within 60 days are valued at amortized
cost, which approximates market value.
Investments for which market quotations are not readily available, or quotations
which management believes are not appropriate, are valued at fair value as
determined in good faith under consistently applied procedures established by
and under the general supervision of the Board of Trustees.
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.
REPURCHASE AGREEMENTS
The Portfolio may engage in repurchase agreement transactions with institutions
that the Portfolio's investment advisor has determined are creditworthy. The
Portfolio, through its custodian, receives delivery of underlying securities
collateralizing a repurchase agreement. Collateral is at least equal, at all
times, to the value of the repurchase obligation including interest. A
repurchase agreement transaction involves certain risks in the event of default
or insolvency of the counterparty. These risks include possible delays or
restrictions upon the Portfolio's ability to dispose of the underlying
securities and a possible decline in the value of the underlying securities
during the period while the Portfolio seeks to assert its rights.
INCOME RECOGNITION
Interest income is recorded on the accrual basis and includes accretion of
discounts and amortization of premiums. Facility fees received are treated as
market discounts. Unamortized facility fees are reflected as deferred fees on
the Statement of Assets and Liabilities.
FEDERAL INCOME TAX STATUS
The Fund intends to qualify each year as a "regulated investment company" under
Subchapter M of the Internal Revenue Code, as amended, and will distribute
substantially all of its taxable income, if any, for its tax year, and as such
will not be subject to federal income taxes. In addition, the Portfolio is
treated as a partnership for federal income tax purposes and all of its income
is allocated to its owners based on methods in compliance with the Internal
Revenue Service. Therefore, no federal income tax provision is recorded.
DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income are declared daily and paid monthly. Net
realized capital gains, if any, are distributed at least annually.
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 Portfolio's Statement of Assets and Liabilities and includes cash on hand at
its custodian bank and does not include any short-term investments.
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.
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.
For the year ended August 31, 2004, permanent differences resulting primarily
from differing treatments for discount accretion/premium amortization on debt
securities were identified and reclassified among the components of the Fund's
net assets as follows:
<Table>
<Caption>
OVERDISTRIBUTED ACCUMULATED
NET INVESTMENT NET REALIZED PAID-IN
INCOME LOSS CAPITAL
- ------------------------------------------------------------
$ 14,128 $ (14,129) $ 1
</Table>
Net investment income and net realized gains (losses), as disclosed on the
Statement of Operations, and net assets were not affected by this
reclassification.
34
<Page>
The tax character of distributions paid during the years ended August 31, 2004
and August 31, 2003 was as follows:
<Table>
<Caption>
AUGUST 31, AUGUST 31,
2004 2003
- --------------------------------------------------------------------------------
DISTRIBUTIONS PAID FROM:
ORDINARY INCOME* $ 3,568,779 $ 5,397,399
</Table>
*For tax purposes short-term capital gains distributions, if any, are considered
ordinary income distributions.
As of August 31, 2004, the components of distributable earnings on a tax basis
were as follows:
<Table>
<Caption>
UNDISTRIBUTED UNDISTRIBUTED
ORDINARY LONG-TERM NET UNREALIZED
INCOME CAPITAL GAINS APPRECIATION*
- -----------------------------------------------------------------------
$ 35,698 $ -- $ 42,839
</Table>
*The differences between book-basis and tax-basis net unrealized
appreciation/depreciation are primarily due to deferral of losses from wash
sales and accretion/amortization on debt securities.
Portfolio unrealized appreciation and depreciation at August 31, 2004, 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:
<Table>
UNREALIZED APPRECIATION $ 59,826,952
UNREALIZED DEPRECIATION (59,232,503)
---------------
NET UNREALIZED APPRECIATION $ 594,449
</Table>
The following capital loss carryforwards may be available to reduce taxable
income arising from future net realized gains on investments, if any, to the
extent permitted by the Internal Revenue Code:
<Table>
<Caption>
YEAR OF CAPITAL LOSS
EXPIRATION CARRYFORWARD
- ----------------------------------------------------------------
2009 $ 16,991
2010 2,799,382
2011 1,685,798
2012 2,947,361
$ 7,449,532
</Table>
NOTE 4. FEES AND COMPENSATION PAID TO AFFILIATES
Effective April 15, 2004, Highland Capital Management, L.P. ("Highland") is the
investment advisor to the Portfolio and the Fund. Prior to April 15, 2004,
Columbia Management Advisors, Inc. ("Columbia") was the investment advisor to
the Portfolio and the Fund. Columbia was an indirect, wholly owned subsidiary of
FleetBoston Financial Corporation ("FleetBoston"), however effective April 1,
2004, FleetBoston, including the Portfolio's and the Fund's investment advisor,
transfer agent and distributor, was acquired by Bank of America Corporation
("BOA"). The change in investment advisor will not impact the Portfolio's
investment strategy.
INVESTMENT ADVISORY FEE
Highland receives a monthly investment advisory fee based on the Portfolio's
average daily net assets at the following annual rates:
<Table>
<Caption>
AVERAGE DAILY NET ASSETS ANNUAL FEE RATE
- -----------------------------------------------------------
FIRST $1 BILLION 0.45%
NEXT $1 BILLION 0.40%
OVER $2 BILLION 0.35%
</Table>
For the period November 1, 2003 through April 14, 2004, Columbia received a
monthly investment advisory fee based on the same fee schedule. Prior to
November 1, 2003, Columbia was entitled to receive a monthly investment advisory
fee at the annual rate of 0.45% of the Portfolio's average daily net assets.
For the year ended August 31, 2004, the Portfolio's effective investment
advisory fee rate was 0.45%.
ADMINISTRATION FEES
During the year ended August 31, 2004, Columbia provided administrative and
other services to the Fund for a monthly administration fee at the annual rate
of 0.20% of the Fund's average daily net assets.
Effective October 18, 2004, Highland replaced Columbia to provide administrative
services to the Fund for a monthly administration fee at the annual rate of
0.20% of the Fund's average daily managed assets. Also effective October 18,
2004, under a separate agreement, Highland has delegated certain administrative
functions to PFPC, Inc. ("PFPC"). PFPC receives a fee from Highland at the
annual rate of 0.01% of the Fund's average daily managed assets.
PRICING AND BOOKKEEPING FEES
During the year ended August 31, 2004, Columbia was responsible for providing
pricing and bookkeeping services to the Portfolio and the Fund under a pricing
and bookkeeping agreement. Under a separate agreement (the "Outsourcing
Agreement"), Columbia delegated those functions to State Street Corporation
("State Street"). As a result, Columbia paid the total fees collected to State
Street under the Outsourcing
35
<Page>
Agreement.
Under its pricing and bookkeeping agreement with the Portfolio and the Fund,
Columbia received from the Portfolio and the Fund an annual flat fee of $10,000
and $5,000, respectively, paid monthly, and in any month that the Fund's average
daily net assets exceeded $50 million, an additional monthly fee. The additional
fee rate was calculated by taking into account the fees payable to State Street
under the Outsourcing Agreement. This rate is applied to the average daily net
assets of the Fund for that month. The Portfolio also paid additional fees for
pricing services based on the number of securities held by the Portfolio. For
the year ended August 31, 2004, the Fund's and the Portfolio's effective pricing
and bookkeeping fee rates, inclusive of out-of-pocket expenses, was 0.031% and
0.030% respectively.
Effective October 18, 2004, the pricing and bookkeeping agreement with Columbia
was terminated, and the Fund entered into a new agreement with PFPC to provide
accounting services.
TRANSFER AGENT FEE
During the year ended August 31, 2004, Columbia Funds Services, Inc. (the
"Transfer Agent"), an affiliate of Columbia, provided shareholder services to
the Fund. For such services, the Transfer Agent received a fee, paid monthly, at
the annual rate of $34.00 per open account. The Transfer Agent also received
reimbursement for certain out-of-pocket expenses.
The Portfolio paid the Transfer Agent a monthly fee equal to $6,000 annually.
Prior to November 1, 2003, the Transfer Agent was entitled to receive a monthly
transfer agent fee, in addition to reimbursement for certain out-of-pocket
expenses, at the annual rate of 0.06% of the Fund's average daily net assets
plus flat-rate charges based on the number of shareholder accounts and
transactions. For the year ended August 31, 2004, the Fund's and the Portfolio's
effective transfer agent fee rate, inclusive of out-of-pocket expenses, was
0.02% and 0.001% respectively. Effective October 18, 2004, PFPC replaced
Columbia Funds Services, Inc., to provide shareholder services to the Fund.
EXPENSE LIMITS AND FEE REIMBURSEMENTS
Highland has voluntarily agreed to waive fees and reimburse certain expenses to
the extent that total expenses (inclusive of allocated Portfolio expenses but
exclusive of brokerage commissions, interest, commitment fees, taxes and
extraordinary expenses, if any) exceed 0.75% annually of the Fund's average
daily net assets. This arrangement may be revised or discontinued by Highland at
any time. Prior to April 15, 2004, Columbia voluntarily waived fees and
reimbursed certain expenses of the Fund based on the same fee structure.
CUSTODY CREDITS
During the year ended August 31, 2004, the Portfolio had an agreement with its
custodian bank under which custody fees may be reduced by balance credits. The
Portfolio could have invested a portion of the assets utilized in connection
with the expense offset arrangement in an income-producing asset if it had not
entered into such an agreement.
Effective October 18, 2004, the agreement with its former custodian bank was
terminated.
FEES PAID TO OFFICERS AND TRUSTEES
Effective August 5, 2004, new officers of the Fund were elected. The Fund pays
no compensation to these officers, all of whom are employees of Highland. Prior
to this date, all of the Fund's officers were employees of Columbia or its
affiliates. The Fund's previous officers also received no compensation from the
Fund.
Effective July 30, 2004, the shareholders of the Fund voted to elect a new Board
of Trustees in connection with the change in Investment Advisor. The Portfolio
pays each Trustee of the Fund a flat rate fee of $20,000 per year for services
provided as a Board member of the Fund. This fee is allocated between the Fund
and the Highland Floating Rate Fund. Prior to July 30, 2004, the previous
Trustees of the Fund participated in a deferred compensation plan. Any
continuing obligations of the plan will be paid solely out of the Fund's assets.
OTHER
Columbia provided certain services to the Fund related to Sarbanes-Oxley
compliance. For the year ended August 31, 2004, the Fund paid $1,428 to Columbia
for such services. This amount is included in "Other expenses" on the Statement
of Operations.
NOTE 5. PORTFOLIO INFORMATION
For the year ended August 31, 2004, the cost of purchases and proceeds from
sales of securities,
36
<Page>
excluding short-term obligations, were $891,194,827 and $612,433,161,
respectively.
NOTE 6. TENDER OF SHARES
The Board of Trustees has adopted a policy of making tender offers on a
quarterly basis. The Board has designated the 15th day of March, June, September
and December of each year, or the next business day if the 15th is not a
business day, as the Repurchase Request Deadline. Tender offers are made for a
portion of the Fund's outstanding shares at the net asset value of the shares as
of the Repurchase Pricing Date. The tender amount, which is determined by the
Board of Trustees, will be at least 5% and no more than 25% of the total number
of shares outstanding on the Repurchase Request Deadline. The Fund may
repurchase an additional amount of shares up to 2% of the shares outstanding on
the Repurchase Request Deadline if the shareholders' offer for repurchase
exceeds the Repurchase Offer Amount. For the year ended August 31, 2004, there
were four tender offers in September, December, March and June. For each tender,
the Fund offered to repurchase 10%, 10%, 10% and 25%, respectively, of its
shares, and 8.50%, 0.00%, 1.28% and 26.81%, respectively, of shares outstanding
were tendered.
NOTE 7. SENIOR LOAN PARTICIPATION COMMITMENTS
The Portfolio invests primarily in participations and assignments, or acts as a
party to the primary lending syndicate of Variable Rate Senior Loan interests to
United States corporations, partnerships, and other entities. If the lead lender
in a typical lending syndicate becomes insolvent, enters FDIC receivership or,
if not FDIC insured enters into bankruptcy, the Portfolio may incur certain
costs and delays in receiving payment or may suffer a loss of principal and/or
interest. When the Portfolio purchases a participation of a senior loan
interest, the Portfolio typically enters into a contractual agreement with the
lender or other third party selling the participation, not with the borrower
directly. As such, the Portfolio assumes the credit risk of the Borrower,
Selling Participant or other persons interpositioned between the Portfolio and
the Borrower. The ability of Borrowers to meet their obligations may be affected
by economic developments in a specific industry.
At August 31, 2004, the following sets forth the selling participants with
respect to interests in senior loans purchased by the Portfolio on a
participation basis.
<Table>
<Caption>
PRINCIPAL
SELLING PARTICIPANT AMOUNT VALUE
- --------------------------------------------------------------------------------
CITIBANK:
INSIGHT HEALTH SERVICES CORP.
TERM LOAN B $ 4,353,030 $ 4,385,678
NEXTEL FINANCE CO, INC.
TERM LOAN E 2,992,481 3,011,645
GOLDMAN SACHS:
BRIDGE INFORMATION SYSTEMS, INC.
MULTIDRAW TERM LOAN 508,890 30,533
</Table>
NOTE 8. UNFUNDED LOAN COMMITMENTS
As of August 31, 2004, the Portfolio had unfunded loan commitments of
$16,117,889, which could be extended at the option of the Borrower, pursuant to
the following loan agreements:
<Table>
<Caption>
UNFUNDED
BORROWER COMMITMENT
- --------------------------------------------------------------------------------
CELANESE $ 1,861,107
CENTENNIAL CELLULAR OPERATING CO - TRANCHE B REVOLVER 2,250,000
CSC HOLDINGS, INC. 395,833
DOBSON CELLULAR SYSTEMS, INC. - REVOLVER 1,016,667
FEDERAL-MOGUL CORP. 109,615
SBA SENIOR FINANCE 484,615
TYCO INTERNATIONAL GROUP SA 10,000,000
-------------
$ 16,117,889
</Table>
NOTE 9. LINE OF CREDIT
During the year ended August 31, 2004, the Portfolio and other affiliated funds
participate in a $350,000,000 credit facility, or emergency purposes to
facilitate portfolio liquidity. Interest was charged to the Portfolio based on
its borrowings. In addition, the Portfolio agreed to pay commitment fees on its
pro-rata portion of the unutilized line of credit. The commitment fee is
included in "Other expenses" on the Statement of Operations. For the year ended
August 31, 2004, the average daily loan balance outstanding on days where
borrowings existed was $36,714,286 at a weighted average interest rate of 1.55%.
Effective September 13, 2004, the $350,000,000 credit facility was terminated
and the Portfolio entered into a $150,000,000 credit facility which replaced the
credit facility mentioned above. The new credit facility is used for temporary
or emergency purposes to facilitate portfolio liquidity. Interest is charged to
the Portfolio based on its
37
<Page>
borrowings. In addition, the Portfolio has agreed to pay commitment fees on the
unutilized line of credit.
NOTE 10. SHARES OF BENEFICIAL INTEREST
As of August 31, 2004, 91.7% of the outstanding shares of the Fund were held by
five shareholders, each of which represents in excess of 5% of the Fund's shares
outstanding. Subscription and redemption activity of these shareholders may have
a material effect on the Fund.
NOTE 11. DISCLOSURE OF SIGNIFICANT RISKS AND CONTINGENCIES
INDUSTRY FOCUS
The Fund may focus its investments in certain industries, subjecting it to
greater risk than a fund that is more diversified.
NON-PAYMENT RISK
Senior Loans, like other corporate debt obligations, are subject to the risk of
non-payment of scheduled interest or principal. Non-payment would result in a
reduction of income to the Portfolio, 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
Securities 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
interest payments. Investments in high-yield Senior Loans may result in greater
net asset value fluctuation than if the Portfolio did not make such investments.
LEGAL PROCEEDINGS
Columbia, Columbia Funds Distributor, Inc. ("CFDI"), certain of their affiliates
and the Fund (collectively, "The Columbia Group"), have received information
requests and subpoenas from various regulatory and law enforcement authorities
in connection with their investigations of late trading and market timing in
mutual funds as well as other industry wide issues.
On February 24, 2004, the Securities and Exchange Commission ("SEC") filed a
civil complaint in the United States District Court for the District of
Massachusetts against Columbia and CFDI, alleging that they had violated certain
provisions of the federal securities laws in connection with trading activity in
mutual fund shares. Also on February 24, 2004, the New York Attorney General
("NYAG") filed a civil complaint in New York Supreme Court, County of New York
against Columbia and CFDI alleging that Columbia and CFDI had violated certain
New York anti-fraud statutes. On March 15, 2004, Columbia and CFDI entered into
agreements in principle with the SEC Division of Enforcement and NYAG in
settlement of the charges. In a separate agreement with the NYAG, the Columbia
Group and its affiliate Banc of America Capital Management, LLC have agreed to
collectively reduce mutual fund fees by $160 million over a five-year period.
As a result of these matters or any adverse publicity or other developments
resulting from them, there may be increased redemptions or reduced sales of fund
shares, which could increase transaction costs or operating expenses, or have
other adverse consequences for the fund.
In connection with the events described in detail above, various parties have
filed suit against certain funds (including the Fund), their Boards and/or
FleetBoston (and affiliated entities). More than 300 cases (including those
filed against entities unaffiliated with the funds, their Boards and/or
FleetBoston and its affiliated entities) have been consolidated in a
multi-district proceeding and transferred to the Federal District Court in
Maryland. Recently, certain Columbia funds and affiliated entities and the Fund
have been named as defendants in several derivative actions under various
sections of the Investment Company Act of 1940, as amended, alleging, among
other things, that the fees and expenses paid by those funds are excessive. The
funds and the other defendants to these actions, including Columbia and various
affiliates, certain other mutual funds advised by Columbia and its affiliates,
and various directors of such funds and the Fund have denied these allegations
and are contesting the plaintiffs' claims. These suits and certain regulatory
investigations are ongoing, however, based on currently available information,
Columbia believes that these lawsuits are without merit and that the likelihood
they will have a material adverse impact on any fund is remote.
38
<Page>
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<Page>
FINANCIAL HIGHLIGHTS
HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY
SELECTED DATA FOR AN INTEREST OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
<Table>
<Caption>
YEAR ENDED AUGUST 31,
2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Total return 10.39% 11.68%(a) (2.20)% 5.15% 8.73%
Operating expenses 0.52%(b) 0.57%(b) 0.55%(b) 0.53%(b) 0.55%
Interest expense --(c) --(c) 0.03% -- --
Net expenses 0.52%(b) 0.57%(b) 0.58%(b) 0.53%(b) 0.55%
Net investment income 4.45%(b) 5.96%(b) 6.42%(b)(d) 8.94%(b) 9.26%
Portfolio turnover rate 97% 75% 70% 63% 21%
</Table>
(a) Total return includes a voluntary reimbursement by the Investment Advisor
for a realized investment loss on an investment not meeting the Portfolio's
investment restrictions. This reimbursement had an impact of less than
0.01% on the Portfolio's return.
(b) The benefits derived from custody credits, and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%
(c) Rounds to less than 0.01%.
(d) Effective September 1, 2001, the Portfolio adopted the provisions of the
AICPA Audit and Accounting Guide for Investment Companies and began
amortizing and accreting premium and discount on debt securities. The
effect of this change for the year ended August 31, 2002, was to increase
the ratio of net investment income to average net assets from 6.41% to
6.42%. Ratios and supplemental data for the periods prior to August 31,
2002 have not been reinstated to reflect this change in presentation.
40
<Page>
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:
<Table>
<Caption>
YEAR ENDED AUGUST 31,
2004 2003 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 9.27 $ 8.81 $ 9.61 $ 10.00 $ 10.07
INCOME FROM INVESTMENT OPERATIONS:
Net investment income 0.41(a) 0.52(a) 0.60(a)(b) 0.87(a) 0.88
Net realized and unrealized gain (loss)
allocated from Portfolio 0.53 0.46 (0.82)(b) (0.40) (0.07)
--------- --------- ---------- ---------- ----------
Total from Investment Operations 0.94 0.98 (0.22) 0.47 0.81
LESS DISTRIBUTIONS DECLARED TO SHAREHOLDERS:
From net investment income (0.42) (0.52) (0.58) (0.85) (0.88)
From net realized gains -- -- -- (0.01) --(c)
--------- --------- ---------- ---------- ----------
Total Distributions Declared
to Shareholders (0.42) (0.52) (0.58) (0.86) (0.88)
NET ASSET VALUE, END OF PERIOD $ 9.79 $ 9.27 $ 8.81 $ 9.61 $ 10.00
Total return (d) 10.25% 11.50%(e) (2.39)% 4.93% 8.52%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net operating expenses 0.75% 0.75% 0.75% 0.75% 0.75%
Interest expense allocated from Portfolio --(f) --(f) 0.03% -- --
Net expenses 0.75% 0.75% 0.78% 0.75% 0.75%
Net investment income 4.29% 5.81% 6.28%(b) 8.90% 8.97%
Waiver/reimbursement 0.15% 0.24% 0.21% 0.10% 0.14%
Net assets, end of period (000's) $ 66,034 $ 89,706 $ 100,912 $ 135,964 $ 184,661
</Table>
(a) Per share data was calculated using average shares outstanding during the
period.
(b) Effective September 1, 2001, the Fund adopted the provisions of the AICPA
Audit and Accounting Guide for Investment Companies and began amortizing
and accreting premium and discount on all debt securities. The effect of
this change for the year ended August 31, 2002 was to increase net
investment income per share by $0.01, and increase net realized and
unrealized loss per share by $0.01. The impact to the ratio of net
investment income to average net assets increased from 6.27% to 6.28%. Per
share data and ratios for periods prior to August 31, 2002 have not been
restated to reflect this change in presentation.
(c) Rounds to less than $0.01.
(d) Had the Investment Advisor not waived or reimbursed a portion of expenses,
total return would have been reduced.
(e) Total return consists of a voluntary reimbursement by the Investment
Advisor for a realized investment loss on an investment not meeting the
Portfolio's investment restrictions. This reimbursement had an impact of
less than 0.01% on the Fund's return.
(f) Rounds to less than 0.01%.
41
<Page>
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE TRUSTEES AND THE SHAREHOLDERS OF HIGHLAND INSTITUTIONAL FLOATING RATE
INCOME FUND AND THE TRUSTEES AND PARTICIPANTS OF HIGHLAND FLOATING RATE LIMITED
LIABILITY COMPANY
In our opinion, the accompanying statements of assets and liabilities, including
the investment portfolio, and the related statements of operations, changes in
net assets and of cash flows and the financial highlights present fairly, in all
material respects, the financial position of Highland Institutional Floating
Rate Income Fund (the "Fund") (formerly Columbia Institutional Floating Rate
Income Fund) and Highland Floating Rate Limited Liability Company (the
"Portfolio") (formerly Columbia Floating Rate Limited Liability Company), at
August 31, 2004, and the results of their operations, the changes in their net
assets, the Portfolio's cash flows and their financial highlights for the
periods indicated, 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 and the Portfolio's management; our responsibility
is to express an opinion on these financial statements based on our audits. We
conducted our audits of these financial statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States),
which require that we plan and perform the audits 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 audits, which included
confirmation of investments held at August 31, 2004 by correspondence with the
custodian and the banks with whom the Portfolio owns participations in loans,
provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
October 27, 2004
42
<Page>
UNAUDITED INFORMATION
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
On July 30, 2004, a Special Meeting of the Shareholders of the Fund was held to
elect five Trustees for the Fund, five Managers for the Portfolio and to approve
a new advisory agreement between Highland Capital Management, L.P. and the
Portfolio. On June 1, 2004, the record date for the Meeting, the Fund had
outstanding 9,138,921.4100 shares of beneficial interest. The votes cast at the
Meeting were as follows:
1. ELECTION OF FIVE (5) TRUSTEES:
<Table>
<Caption>
FOR WITHHELD BROKER NON-VOTES
--- -------- ----------------
Timothy K. Hui 5,455,759.2060 81,995.3050 0
Scott F. Kavanaugh 5,455,759.2060 81,995.3050 0
James F. Leary 5,455,759.2060 81,995.3050 0
Brian A. Ward 5,455,759.2060 81,995.3050 0
R. Joseph Dougherty 5,455,759.2060 81,995.3050 0
</Table>
2. ELECTION OF FIVE (5) MANAGERS:
<Table>
<Caption>
FOR WITHHELD BROKER NON-VOTES
--- -------- ----------------
Timothy K. Hui 5,455,759.2060 81,995.3050 0
Scott F. Kavanaugh 5,455,759.2060 81,995.3050 0
James F. Leary 5,455,759.2060 81,995.3050 0
Brian A. Ward 5,455,759.2060 81,995.3050 0
R. Joseph Dougherty 5,455,759.2060 81,995.3050 0
</Table>
3. TO APPROVE THE FUND'S ADVISORY AGREEMENT BETWEEN HIGHLAND CAPITAL MANAGEMENT,
L.P. AND THE PORTFOLIO:
<Table>
For: 5,455,759.21 shares of beneficial interest
being a majority of the shares
represented at the Meeting
Against: 81,995.31 shares of beneficial interest
Abstain: 0.00 shares of beneficial interest
Broker Non-Votes: 0
</Table>
43
<Page>
TRUSTEES
HIGHLAND FLOATING RATE FUND
The Trustees serve terms of indefinite duration. The names, addresses 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 trustee and officer listed below
serves in the same capacity for the other three Highland Funds and for the two
Prospect Street Funds (Prospect Street(R) High Income Portfolio Inc. and
Prospect Street(R) Income Shares Inc. (two closed-end funds advised by
Highland). The Statement of Additional Information (SAI) contains additional
information about the Trustees and is available without charge upon request by
calling the fund's distributor at 877-665-1287.
<Table>
<Caption>
NAME, ADDRESS AND AGE, POSITION WITH THE FUND, PRINCIPAL OCCUPATION(s) DURING PAST FIVE YEARS, OTHER DIRECTORSHIPS HELD
YEAR FIRST ELECTED OR APPOINTED TO OFFICE
DISINTERESTED TRUSTEES
TIMOTHY K. HUI (age 55) Assistant Provost for and, since September 1998, Director of Learning
48 Willow Greene Drive Resources of the Philadelphia Biblical University.
Churchville, PA 18966
Trustee (since 2004)
SCOTT F. KAVANAUGH (age 43) Since March 2003, Sales Representative at Round Hill Securities. From
9 Old Ranch Road February 2003 to July 2003, Executive at Provident Funding Mortgage
Laguna Niguel, CA 92677 Corporation. From January 2000 to February 2003, Executive Vice President,
Trustee (since 2004) Director and Treasurer of Commercial Capital Bank. From April 1998 to
February 2003, Managing Principal and Chief Operating Officer of Financial
Institutional Partners Mortgage Company and Managing Principal and President
of Financial Institutional Partners, LLC, an investment banking firm.
JAMES F. LEARY (age 73) Since January 1999, Managing Director of Benefit Capital Southwest, Inc., a
15851 N. Dallas Parkway financial consulting firm. Director for Capstone Asset Management Group of
Suite 500 Mutual Funds (nine portfolios)
Addison, Texas 75001
Trustee (since 2004)
BRYAN A. WARD (age 49) Since January 2002, Senior Manager of Accenture, LLP, a consulting firm.
901 Main Street From September 1998 to December 2001, Special Projects Advisor, Contractor
Dallas, Texas 75202 and Information Technology consultant to Accenture, LLP.
Trustee (since 2004)
INTERESTED TRUSTEE
R. JOSEPH DOUGHERTY (age 34) Since January 2003, Senior Portfolio Manager of Highland. From January 1999
13455 Noel Road Suite 1300 to January 2003, Portfolio Manager of Highland. Prior to January 1999,
Dallas, TX 75240 Portfolio Analyst for Highland.
Trustee (since 2004)
</Table>
44
<Page>
OFFICERS
HIGHLAND FLOATING RATE FUND
<Table>
<Caption>
NAME, ADDRESS AND AGE, POSITION WITH THE FUND, PRINCIPAL OCCUPATION(s) DURING PAST FIVE YEARS
YEAR FIRST ELECTED OR APPOINTED TO OFFICE
JAMES D. DONDERO (42) President and Managing Partner of the Highland.
13455 Noel Road Suite 1300
Dallas, TX 75240
President (Since August 5, 2004)
MARK K. OKADA (43) Chief Investment Officer of the Adviser.
13455 Noel Road Suite 1300
Dallas, TX 75240
Executive Vice President (Since August 5, 2004)
R. JOSEPH DOUGHERTY (34) Since January 2003, Senior Portfolio Manager of Highland. From January 1999
13455 Noel Road Suite 1300 to January 2003, Portfolio Manager of Highland. Prior to January 1999,
Dallas, TX 75240 Portfolio Analyst for Highland.
Senior Vice President (Since August 5, 2004)
M. JASON BLACKBURN (28) Assistant Controller of the Highland. From September 1999 to October 2001,
13455 Noel Road Suite 1300 an accountant for KPMG LLP.
Dallas, TX 75240
Secretary and Treasurer (Since August 5, 2004)
</Table>
45
<Page>
IMPORTANT INFORMATION ABOUT THIS REPORT
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
TRANSFER AGENT
PFPC Inc.
400 Bellevue
Wilmington, DE 19809
877.665.1287
DISTRIBUTOR
PFPC Distributors, Inc.
760 Moore Road
King of Prussia, PA 19406
INVESTMENT ADVISOR
Highland Capital Management, L.P.
13455 Noel Rd. Suite 1300
Dallas, TX 75240
INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
PricewaterhouseCoopers LLP
125 High Street
Boston, MA 02110
The fund mails one shareholder report to each shareholder address. If you would
like more than one report, please call shareholder services at 877-665-1287 and
additional reports will be sent to you.
This report has been prepared for shareholders of Highland Institutional
Floating Rate Income 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 877-665-1287 and (ii) on the
Securities and Exchange Commission's website at http://www.sec.gov.
The Fund will file 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, beginning with the fiscal quarter ending November 30,
2004. 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.
46
<Page>
[THIS PAGE INTENTIONALLY LEFT BLANK.]
<Page>
[THIS PAGE INTENTIONALLY LEFT BLANK.]
<Page>
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND PRSRT STD
ANNUAL REPORT, AUGUST 31, 2004 U.S. POSTAGE
PAID
HOLLISTON, MA
PERMIT NO. 20
[HIGHLAND FUNDS LOGO]
MANAGED BY
HIGHLAND CAPITAL MANAGEMENT, L.P.
PFPC DISTRIBUTORS, INC.
760 MOORE ROAD
KING OF PRUSSIA, PA 19406
www.highlandfunds.com
S87-02/779S-0904 (10/04) 2926
<Page>
ITEM 2. CODE OF ETHICS.
The Registrant 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.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
The Registrant's Board of Trustees (the "Board") has determined that
James Leary, a member of the Audit Committee of the Board, is an audit committee
financial expert as defined by the Securities and Exchange Commission (the
"SEC"). Mr. Leary is "independent" as defined by the SEC for purposes of audit
committee financial expert determinations.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) AUDIT FEES. The aggregate fees billed for each of the last two
fiscal years (the "Reporting Periods") for professional services rendered by the
Registrant's principal accountant (the "Auditor") for the audit of the
Registrant's annual financial statements, or services that are normally provided
by the Auditor in connection with the statutory and regulatory filings or
engagements for the Reporting Periods, were $9,060 in 2003 and $8,240 in 2004.
(b) AUDIT-RELATED FEES. The aggregate fees billed in the Reporting
Periods for assurance and related services by the Auditor 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 4 were $4,000 in 2003 and
$3,500 in 2004. These services consisted of the review of the semi-annual
financial statements, and agreed-upon procedures required by lending
organizations.
The aggregate fees billed in the Reporting Periods for non-audit
assurance and related services by the Auditor to the Registrant's investment
adviser (not including any sub-investment 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
("Service Affiliates") which required pre-approval by the Audit Committee were
$0 in 2003 and $0 in 2004 that were reasonably related to the performance of the
annual audit of the Service Affiliate.
2
<Page>
(c) TAX FEES. The aggregate fees billed in the Reporting Periods for
professional services rendered by the Auditor for tax compliance, tax advice and
tax planning ("Tax Services") were $2,000 in 2003 and $2,112 in 2004. These
services consisted of (i) review 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.
The aggregate fees billed in the Reporting Periods for Tax Services by
the Auditor to Service Affiliates which required pre-approval by the Audit
Committee were $0 in 2003 and $0 in 2004.
(d) ALL OTHER FEES. The aggregate fees billed in the Reporting Periods
for products and services provided by the Auditor, other than the services
reported in paragraphs (a) through (c) of this Item, were $0 in 2003 and $0 in
2004.
The aggregate fees billed in the Reporting Periods for Non-Audit
Services by the Auditor to Service Affiliates, other than the services reported
in paragraphs (b) through (d) of this Item, which required pre-approval by the
Audit Committee were $95,000 in 2003 and $95,000 in 2004.
NON-AUDIT FEES. The aggregate non-audit fees billed by the Auditor for
services rendered to the Registrant, and rendered to Service Affiliates, for the
Reporting Periods were $0 in 2003 and $0 in 2004.
AUDITOR INDEPENDENCE. The Registrant's Audit Committee has considered
whether the provision of non-audit services that were rendered to Service
Affiliates which were not pre-approved (not requiring pre-approval) is
compatible with maintaining the Auditor's independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
ITEM 6. SCHEDULE OF INVESTMENTS.
Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Registrant has delegated voting of proxies in respect of portfolio
holdings to its investment adviser, Highland Capital Management, L.P. ("HCMLP"),
to vote the Registrant's proxies in accordance with HCMLP's proxy voting
guidelines and procedures. HCMLP has adopted proxy voting guidelines (the
"Guidelines") that provide as follows:
- HCMLP votes proxies in respect of the Registrant's securities in the
Registrant's best interests and without regard to the interests of HCMLP or
any client of HCMLP.
3
<Page>
- Unless HCMLP's Proxy Voting Committee (the "Committee") otherwise
determines (and documents the basis for its decisions) or as otherwise
provided below, HCMLP votes proxies in a manner consistent with the
Guidelines.
- To avoid material conflicts of interest, HCMLP applies the Guidelines in an
objective and consistent manner across the Registrant's accounts. Where a
material conflict of interest has been identified and the matter is covered
by the Guidelines, the Committee votes in accordance with the Guidelines.
For the Registrant, where a conflict of interest has been identified and
the matter is not covered in the Guidelines, HCMLP will disclose the
conflict and the Committee's determination of the matter in which to vote
to the Registrant's Board.
- HCMLP also may determine not to vote proxies in respect of securities of
the Registrant if it determines it would be in the Registrant's best
interests not to vote.
HCMLP's Guidelines also address how it will vote proxies on particular
types of matters such as corporate governance matters, disclosure of executive
compensation and share repurchase programs. For example, HCMLP generally will:
- Support management in most elections for directors, unless the board gives
evidence of acting contrary to the best economic interests of shareholders;
- Support proposals seeking increased disclosure of executive compensation;
and
- Support management proposals to institute share repurchase plans in which
all shareholders may participate on equal terms.
ITEM 8. PURCHASE OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANIES AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 9. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Registrant has a Nominating Committee (the "Committee") of the
Board responsible for selecting and nominating persons as members of the Board
for election or appointment by the Board and for election by stockholders. The
Committee has adopted a Nominating Committee Charter (the "Charter"), pursuant
to which the Committee will consider recommendations for nominees from
stockholders submitted to the Secretary of the Registrant, Two Galleria Tower,
13455 Noel Road, Dallas, Texas 75240. In evaluating potential nominees,
including any nominees recommended by stockholders, the Committee takes into
consideration various factors including character and integrity, business and
professional experience, and whether the Committee believes the person has the
ability to apply sound and independent business judgment and would act in the
interest of the Registrant and its stockholders. Submissions must include all
information relating to the recommended nominee that is required to be disclosed
in solicitations or proxy statements for the election of Board members, as well
as information sufficient to evaluate the factors to be considered by the
Committee. Submissions must be accompanied by a written consent of the
individual to stand for election if nominated by the Board and to serve if
elected by the stockholders, and such additional information must be provided
regarding the recommended nominee as reasonably requested by the Committee.
ITEM 10. CONTROLS AND PROCEDURES.
(a) The Registrant's principal executive and principal financial
officers have concluded, based on their evaluation of the Registrant's
disclosure controls and procedures as of a date within 90 days of
4
<Page>
the filing date of this report, that the Registrant's disclosure controls and
procedures are reasonably designed to ensure that information required to be
disclosed by the Registrant on Form N-CSR is recorded, processed, summarized and
reported within the required time periods and that information required to be
disclosed by the Registrant in the reports that it files or submits on Form
N-CSR is accumulated and communicated to the Registrant's management, including
its principal executive and principal financial officers, as appropriate to
allow timely decisions regarding required disclosure.
(b) There were no changes to the Registrant's internal control over
financial reporting that occurred during the Registrant's most recently ended
fiscal half-year that have materially affected, or are reasonably likely to
materially affect, the Registrant's internal control over financial reporting.
ITEM 11. EXHIBITS.
(a)(1) Code of ethics referred to in Item 2.
(a)(2) Certifications of principal executive and principal financial
officers as required by Rule 30a-2(a) under the Investment Company Act of 1940.
(a)(3) Not applicable.
(b) Certification of principal executive and principal financial
officers as required by Rule 30a-2(b) under the Investment Company Act of 1940.
5
<Page>
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.
HIGHLAND INSTITUTIONAL FLOATING RATE INCOME FUND
By: /s/ James D. Dondero
----------------------
James D. Dondero
Chief Executive Officer
Date: November 09, 2004
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: /s/ James D. Dondero
----------------------
James D. Dondero
Chief Executive Officer
Date: November 09, 2004
By: /s/ M. Jason Blackburn
----------------------
M. Jason Blackburn
Chief Financial Officer
Date: November 09, 2004
EXHIBIT INDEX
(a)(1) Code of ethics referred to in Item 2.
(a)(2) Certifications of principal executive and principal financial
officers as required by Rule 30a-2(a) under the Investment Company Act
of 1940. (EX-99.CERT)
(b) Certification of principal executive and principal financial
officers as required by Rule 30a-2(b) under the Investment Company Act
of 1940. (EX-99.906CERT)
6