<PAGE>
December 20, 1996
LETTER TO SHAREHOLDERS
Dear Shareholders:
On October 31, 1996, the net asset value of the Fund was $3.90, as compared
to $3.70 on October 31, 1995. During the fiscal year ended October 31, 1996, the
Fund paid dividends to shareholders on the common stock in the amount of $0.42
per share. Total dividends paid for the calendar year ending December 31, 1996
will be $0.42.
THE HIGH YIELD MARKET:
The High Yield market, as measured by the C S First Boston Index, generated
an annualized total return of 10.47% for the twelve month period ended October
31, 1996. The spread between high yield securities and comparable U.S.
government securities stood at 404 basis points at October 31, 1996, compared to
457 basis points at October 31, 1995. Total new issue volume through October 31,
1996 approximated $55.3 billion split nearly evenly between registered public
issues and Rule 144A issues. The average price of a cash paying high yield
security was $98.21 with an average coupon of approximately 10.42%. The flow of
money into high yield mutual funds continued at a high level throughout 1996,
averaging between $200 million and $300 million per week. Total assets in high
yield mutual funds exceeded $75 billion at October 31, 1996, as compared to $60
billion one year earlier.
THE FUND'S INVESTMENTS:
The total return on the Fund's common stock for the twelve months ended
October 31, 1996, assuming reinvestment of dividends, was approximately 15.29%.
As of October 31, 1996, the Fund held 189 issues representing 29 industry
groups. The average price of the Fund's high yield securities was $95.81 with an
average coupon of 10.97%. At October 31, 1996, the Fund was generating monthly
net investment income of approximately $0.035 per common share.
INVESTMENT OUTLOOK:
The high yield market has performed well since October of 1995. Factors that
would be expected to extend a favorable outlook for high yield securities are:
1. Cash flows into high yield funds remain strong and the cash positions
of many high yield funds remain high.
2. The Federal Reserve continues its policy of accommodation to maintain
the economy on a steady growth rate but at a lower rate than past
economic expansions.
3. Pricing pressures remain subdued throughout the economy which
enhances the attraction of high yield securities.
4. Weak economic growth of the other major industrial countries,
particularly Japan and Germany, has forced their central banks to
keep interest rates low and to encourage a weaker currency versus the
US dollar. It may be necessary for the US Federal Reserve to lower
interest rates to restrain the dollar's appreciation in order to
protect the United States industrial competitive position.
Some of the factors that could negatively impact the high yield market are:
1. The S&P 500 is currently valued at a price-earnings ratio of 21 times
a level historically associated with market tops. A significant
correction in the S&P 500 would probably result in a strong
correction in the high yield market.
2. The business expansion is fairly extended and could slow down more
sharply in 1997 than most observers currently anticipate. A weaker
economy affects below investment grade credits disproportionately,
which could increase defaults and give rise to credit problems.
3. Corporate earnings could come under pressure simply from a slowdown
in revenue due to an inability to raise or maintain prices. This
inability to raise or maintain prices would have greater impact on
highly leveraged companies and on small companies, which are the type
of companies that issue high yield debt.
4. More difficult times result in investors being more risk adverse,
resulting in a flight from low quality into higher quality
investments. If this were to happen, the current yield spread between
high grade and low grade debt instruments could widen and investment
funds would be disintermediated out of high yield investments into
higher grade investments.
CONCLUSION:
The fiscal year ended October 31, 1996 has been a period of strength in the
high yield market. Longer term interest rates are again declining and short term
interest rates have begun to decline. With cash flows into high yield funds
remaining strong the outlook for the high yield market appears to provide a
favorable opportunity in the near term.
Management continues to review the Fund's investments, eliminating issues
that appear fully-priced or vulnerable to either interest rate risk or
disappointing financial results.
Respectfully submitted,
/s/ Richard E. Omohundro, Jr.
Richard E. Omohundro, Jr.
President
/s/ John A. Frabotta
John A. Frabotta
Vice President and
Chief Investment Officer
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
SCHEDULE OF INVESTMENTS
OCTOBER 31, 1996
<TABLE>
FIXED INCOME -- 89.52%
<CAPTION>
Ratings
-------------------
Par Standard Value
Value Description & Poor's Moody's (Note 2)
----- ----------- -------- ------- --------
<C> <S> <C> <C> <C>
AEROSPACE AND DEFENSE - 0.57%
$1,000,000 Sabreliner Corp., 12 1/2%, sr. notes, series B, 04/15/03 ......... B+ B2 $ 933,750
------------
AGRICULTURAL CHEMICALS/FARMING - 1.45%
500,000 Calmar Spraying Systems Inc., 11 1/2%, sr. sub. notes, 08/15/05 .. B- B3 491,250
500,000 Hines Horticulture Inc., 11 3/4%, sr. sub. notes, 10/15/05 ....... B- B3 528,750
1,250,000 LaRoche Industries Inc., 13%, sr. sub. notes, 08/15/04 ........... B B3 1,350,000
------------
2,370,000
------------
AUTOMOBILE/AUTO PARTS/TRUCK MANUFACTURING - 4.63%
1,000,000 AM General Corp., 12 7/8%, sr. notes, series B, 05/01/02 ......... B- B3 960,000
1,000,000 Aetna Industries Inc., 11 7/8%, sr. notes, 144A, 10/01/06 ........ B- B3 1,022,500
1,000,000 CSK Auto Inc., 11%, sr. sub. notes, 144A, 11/01/06 ............... B- B3 1,000,000
500,000 Great Dane Holdings Inc., 12 3/4%, sr. sub. deb., 08/01/01 ....... CCC Caa 491,875
1,000,000 Harvard Industries Inc., 12%, sr. notes, 07/15/04 ................ B+ B3 940,000
1,500,000 Iochpe-Maxion SA, 12 3/8%, notes, 11/08/02 ....................... NR NR 1,470,000
500,000 Poindexter, J.B., Inc., 12 1/2%, sr. notes, 05/15/04 ............. B+ B2 482,500
500,000 Speedy Muffler King Inc., 10 7/8%, sr. notes, 10/01/06 ........... B+ B1 505,000
781,000 Venture Holdings Trust, 9 3/4%, sr. sub. notes, 04/01/04 ......... B B3 695,090
------------
7,566,965
------------
BANKS/SAVINGS AND LOANS/FINANCE COMPANIES/
CONSUMER CREDIT - 2.35%
1,000,000 Berkeley Federal Bank & Trust, 12%, sub. deb., 06/15/05 .......... B+ B1 1,080,000
1,000,000 Central Rents Inc., 12 7/8%, sr. notes, series B, 12/15/03 ....... NR B3 1,062,500
500,000 Imperial Credit Industry Inc., 9 3/4%, sr. notes, 01/15/04 ....... B B1 487,500
1,000,000 Lomas Mortgage USA Inc., 10 1/4%, sr. notes, 10/01/02 ............ D Ca 685,000
500,000 Ocwen Financial Corp., 11 7/8%, notes, 10/01/03 .................. B+ B1 525,000
------------
3,840,000
------------
BROADCASTING - TV/CABLE/RADIO/PUBLISHING - 9.62%
500,000 Adelphia Communication, 9 7/8%, sr. notes, 03/01/05 .............. B B3 435,000
1,000,000 Adelphia Communication, 12 1/2%, sr. notes, 05/15/02 ............. B B3 990,000
1,000,000 Allbritton, 11 1/2%, sr. sub. notes, 08/15/04 .................... B- B3 1,040,000
1,000,000 Australis Media Ltd., 0%, sr. sub. disc. notes, 05/15/03 ......... NR NR 590,000
1,000,000 Bell Cable Media Plc., 0%, sr. disc. notes, 09/15/05 ............. BB- B2 750,000
500,000 Busse Broadcasting Corp., 11 5/8%, sr. secd. notes, 10/15/00 ..... NR B3 501,250
6,000,000 DIVA Systems Corp., 13%, sub. disc. notes, 05/15/06 .............. NR NR 3,420,000
750,000 Emerson Radio Corp., 8 1/2%, conv. sub. deb., 144A, 08/15/02 ..... NR NR 525,000
500,000 Galaxy Telecom, L.P., 12 3/8%, sr. sub. notes, 10/01/05 .......... B- B3 525,000
500,000 Knoll Inc., 10 7/8%, sr. sub. notes, 03/15/06 .................... B+ B3 535,000
750,000 Marcus Cable Co., L.P., 11 7/8%, sr. deb., 10/01/05 .............. B Caa 785,625
1,000,000 Mobile Media Communications, 9 3/8%, sr. sub. notes, 11/01/07 .... CCC B3 545,000
750,000 Paxson Communications Corp., 11 5/8%, sr. sub. notes, 10/01/02 ... NR B3 765,000
500,000 RBS Participaco, 14%, notes, 12/15/03 ............................ NR NR 542,500
1,000,000 Sinclair Broadcasting Group, 10%, sr. sub. notes, 09/30/05 ....... B B2 972,500
500,000 Sullivan Graphics Inc., 12 3/4%, sr. sub. notes, 08/01/05 ........ NR Caa 485,000
1,000,000 UIH Australia Pac Inc., 14%, sr. disc. notes, series B, 05/15/06 NR B2 530,000
1,000,000 United International Holdings Inc., 0%, sr. secd. disc. notes,
11/15/99 ...................................................... B- B3 700,000
325,000 Winstar Communications Inc., 14%, sr. sub. disc. notes, 10/15/05 . NR NR 201,500
650,000 Winstar Communications Inc., 14%, sr. disc. notes, 10/15/05 ...... NR NR 364,000
500,000 Wireless One Inc., 13%, sr. disc. notes, 10/15/03 ................ B- B3 512,500
------------
15,714,875
------------
CHEMICALS/PLASTICS - 2.49%
1,000,000 Astor Corp., 10 1/2%, sr. sub. notes, 144A, 10/15/06 ............. B- B3 995,000
1,000,000 Key Plastics Inc., 14%, sr. notes, series B, 11/15/99 ............ B+ B2 1,030,000
1,000,000 Plastic Specialties & Technologies Inc., 11 1/4%, sr. notes,
12/01/03 ....................................................... B- B3 1,030,000
500,000 Spinnaker Industries Inc., 10 3/4%, sr. secd. notes, 144A,
10/15/06 ....................................................... B B3 507,500
500,000 Sterling Chemicals Inc., 11 3/4%, sr. sub. notes, 08/15/06 ....... B+ B3 512,500
------------
4,075,000
------------
DIVERSIFIED/CONGLOMERATE MANUFACTURING - 3.11%
500,000 Aftermarket Technology Corp., 12%, sr. sub. notes, series B,
08/01/04 ...................................................... NR B3 550,000
1,000,000 Genmar Holdings Inc., 13 1/2%, sr. sub. notes, series A, 07/15/01 CCC- Caa 950,000
1,000,000 Haynes International Inc., 11 5/8%, sr. notes, 09/01/04 .......... B- B3 1,042,500
500,000 IMO Industries Inc., 11 3/4%, sr. sub. notes, 05/01/06 ........... B- B3 503,750
500,000 Jordan Industries Inc., 10 3/8%, sr. notes, 08/01/03 ............. B+ B3 490,000
500,000 MVE Inc., 12 1/2%, sr. secd. notes, 02/15/02 ..................... B+ B3 530,000
500,000 Mail-Well Envelope Corp., 10 1/2%, sr. sub. notes, 02/15/04 ...... B B2 500,000
500,000 Selmer Inc., 11%, sr. sub. notes, 05/15/05 ....................... B- B3 520,000
------------
5,086,250
------------
DIVERSIFIED CONGLOMERATE SERVICES - 0.71%
550,000 Coinmach Corp., 11 3/4%, sr. notes, series B, 11/15/05 ........... B+ B2 589,875
500,000 Primeco Inc., 12 3/4%, sr. sub. notes, 03/01/05 .................. B B3 562,500
------------
1,152,375
------------
ELECTRICAL EQUIPMENT/ELECTRONICS/COMPUTERS - 3.14%
1,000,000 Advanced Micro Devices Inc., 11%, sr. secd. notes, 08/01/03 ...... BB- Ba1 1,052,500
1,000,000 Computervision Corp., 11 3/8%, sr. sub. notes, 08/15/99 .......... B- B3 1,047,500
500,000 International Wire Group Inc., 11 3/4%, sr. sub. notes, 06/01/05 . B- B3 527,500
1,000,000 National Semiconductor Corp., 6 1/2%, conv. sub. notes, 144A,
10/01/02 ....................................................... BB Ba2 943,750
990,000 Real Time Data Inc., 0%, sub. disc. notes, 08/15/06 .............. NR NR 534,600
500,000 United Stationers Supply Co., 12 3/4%, sr. sub. notes, 05/01/05 .. B- B3 547,500
500,000 VLSI Technology Inc., 8 1/4%, conv. sub. notes, 10/01/05 ......... B NR 475,000
------------
5,128,350
------------
FINANCIAL SERVICES-BROKERAGE/SYNDICATION/LEASING - 0.92%
1,000,000 Beal Financial Corp., 12 3/4%, sr. notes, 08/15/00 ............... B- B2 1,060,000
425,000 First Federal Financial Corp., 11 3/4%, notes, 10/01/04 .......... B+ B2 448,375
------------
1,508,375
------------
FOOD AND TOBACCO - 8.32%
390,218 American Restaurant Group, 13%, sr. secd. notes, 09/15/98 ........ B- Caa 343,392
1,000,000 American Rice Inc., 13%, mtg. notes, 07/31/02 .................... B- Caa 910,000
1,000,000 BGLS, Inc., 15 3/4%, sr. secd. notes, series B, 01/31/01 ......... NR NR 750,000
1,250,000 Curtice Burns Foods Inc., 12 1/4%, sr. sub. notes, 02/01/05 ...... B B3 1,225,000
1,000,000 Doane Products Co., 10 5/8%, sr. notes, 03/01/06 ................. B+ B3 1,045,000
1,500,000 FRD Acquisition Co., 12 1/2%, sr. notes, series B, 07/15/04 ...... NR NR 1,500,000
1,000,000 Fleming Companies Inc., 10 5/8%, sr. notes, 12/15/01 ............. B+ Ba3 990,000
500,000 International Home Foods, 10 3/8%, sr. sub. notes, 144A, 11/01/06 B- B2 500,000
500,000 Liggett Group Inc., 11 1/2%, gtd. sr. secd. notes, series B,
02/01/99 ....................................................... NR NR 340,000
250,000 Liggett Group Inc., 16 1/2%, notes, 02/01/99 ..................... NR NR 222,500
1,500,000 P&C Food Markets Inc., 11 1/2%, deb., 10/15/01 ................... BB- B1 1,305,000
1,000,000 Specialty Foods Corp., 11 1/4%, sr. sub. notes, sereis B, 08/15/03 B Caa 795,000
1,000,000 Spreckels Industries Inc., 11 1/2%, gtd. sr. secd. notes, 09/01/00 B B2 1,072,500
300,000 Standard Communications Corp., 7 1/4%, conv. sub. deb., 03/31/07 . B B3 233,625
1,000,000 Stroh Brewery Co., 11.10%, sr. sub. notes, 07/01/06 .............. NR NR 1,042,500
500,000 TLC Beatrice International Holdings Inc., 11 1/2%,
sr. secd. notes, 10/01/05 ...................................... BB- B1 505,000
750,000 Van de Kamps Inc., 12%, sr. sub. notes, 09/15/05 ................. B- B2 817,500
------------
13,597,017
------------
GENERAL & SPECIALTY RETAIL - 2.92%
1,000,000 Finlay Fine Jewelry Corp., 10 5/8%, sr. notes, 05/01/03 .......... B B1 1,030,000
750,000 Hills Stores Co., 12 1/2%, sr. notes, 144A, 07/01/03 ............. NR B1 675,000
500,000 Loehmanns Inc., 11 7/8%, sr. notes, 05/15/03 ..................... B B2 530,000
1,000,000 Mothers Work Inc., 12 5/8%, sr. notes, 08/01/05 .................. B+ B3 1,010,000
1,000,000 SRI Receivable Pure Inc., 12 1/2%, notes, 144A, 12/15/00 ......... NR NR 1,010,000
500,000 Specialty Retailers Inc., 11%, sr. sub. notes, series B, 08/15/03 B- B3 510,000
------------
4,765,000
------------
GROCERY/CONVENIENCE - 4.01%
3,000,000 Cumberland Farms Inc., 10 1/2%, gtd. secd. notes, 10/01/03 ....... NR NR 2,947,500
500,000 Grand Union Co., 12%, sr. notes, 09/01/04 ........................ B- B3 506,250
500,000 Jitney Jungle Stores, 12%, sr. notes, 03/01/06 ................... B B2 540,000
500,000 Pantry Inc., 12%, sr. notes, series B, 11/15/00 .................. B B2 440,000
1,000,000 Pathmark Stores Inc., 12 5/8%, sub. deb., 06/15/02 ............... B- B3 1,040,000
500,000 Ralph's Supermarkets Inc., 13 3/4%, sr. sub. notes, 06/15/05 ..... B- B3 531,875
500,000 Star Markets Company, Inc., 13%, sr. sub. notes, 11/01/04 ........ CCC+ B3 545,000
------------
6,550,625
------------
HEALTHCARE/DRUGS/HOSPITAL SUPPLIES - 2.33%
750,000 Complete Management Inc., 8%, conv. sub. deb., 08/15/03 .......... NR NR 930,000
1,000,000 Eye Care Centers of America Inc., 12%, sr. notes, 10/01/03 ....... B+ B3 1,070,000
500,000 Health O Meter Inc., 13%, sr. sub. notes, 08/15/02 ............... B- B3 550,000
250,000 Maxxim Medical Inc., 10 1/2%, sr. sub. notes, 08/01/06 ........... B B3 250,000
1,000,000 Unison Healthcare Corp., 12 1/4%, sr. notes, 144A, 11/01/06 ...... B B3 1,000,000
------------
3,800,000
------------
HOME FURNISHINGS/DURABLE CONSUMER PRODUCTS - 2.00%
2,000,000 CS Wireless Systems Inc., 11 3/8%, units, 03/01/06 ............... NR NR 930,000
1,000,000 Lanesborough Corp., 10%, sr. notes, 04/15/00 ..................... NR NR 830,000
1,130,000 Levitz Furniture Corp., 9 5/8%, sr. sub. notes, 07/15/03 ......... CCC Caa 463,300
1,000,000 Simmons Co., 10 3/4%, sr. sub. notes, 04/15/06 ................... B B2 1,035,000
------------
3,258,300
------------
HOTEL/GAMING - 0.51%
500,000 Courtyard by Marriott II, 10 3/4%, sr. secd. notes, 02/01/08 ..... B- NR 517,500
419,000 U.S. Trails Inc., 12%, sr. sub. pik notes, 07/15/03 .............. NR NR 314,250
------------
831,750
------------
LEISURE/AMUSEMENT/MOTION PICTURES - 3.33%
1,250,000 Act III Theatres Inc., 11 7/8%, sr. sub. notes, 02/01/03 ......... NR B3 1,359,375
2,000,000 Baldwin Company, 10 3/8%, sr. notes, series B, 08/01/03 .......... D Ca 820,000
500,000 Guitar Centers Management Co., Inc., 11%, sr. notes, 144A,
07/01/06 ....................................................... B B2 525,000
250,000 Live Entertainment Inc., 12%, sr. secd. sub. notes, 03/23/99 ..... NR NR 240,000
2,000,000 Marvel III Holdings Inc., 9 1/8%, sr. secd. notes, series B,
02/15/98 ....................................................... CCC+ Caa 910,000
3,500,000 Musicland Group Inc., 9%, sr. sub. notes, 06/15/03 ............... CCC+ B3 1,050,000
500,000 Premier Parks Inc., 12%, sr. notes, series A, 08/15/03 ........... B+ B2 541,250
------------
5,445,625
------------
MACHINERY - 0.67%
500,000 Newflo Corp., 13 1/4%, sub. notes, 11/15/02 ...................... B- B3 551,250
500,000 Specialty Equipment Companies Inc., 11 3/8%, sr. sub. notes,
12/01/03 ....................................................... B B3 540,000
------------
1,091,250
------------
METALS/MINING - 6.35%
1,500,000 Algoma Steel Inc., 12 3/8%, 1st mtg. notes, 07/15/05 ............. B B1 1,552,500
1,000,000 Bayou Steel Corporation, 10 1/4%, 1st mtg. notes, 03/01/01 ....... B B2 920,000
750,000 GS Technologies Inc., 12%, gtd. sr. notes, 09/01/04 .............. B B2 765,000
1,000,000 ICF Kaiser International Inc., 13%, sr. sub. notes, 12/31/03 ..... B- B3 980,000
1,000,000 ICF Kaiser International Inc., 12%, units, 12/31/03 .............. B- B3 980,000
500,000 IVACO Inc., 11 1/2%, sr. notes, 09/15/05 ......................... B+ B1 483,750
1,000,000 Maxxam Group Inc., 11 1/4%, sr. secd. notes, 08/01/03 ............ B- B3 995,000
1,000,000 Renco Metals Inc., 11 1/2%, sr. notes, 07/01/03 .................. B B2 1,047,500
500,000 Sheffield Steel Corp., 12%, 1st mtg. notes, 11/01/01 ............. B- Caa 470,000
750,000 Sheffield Steel Corp., 12%, 1st mtg. notes, 11/01/01 ............. B- Caa 705,000
1,000,000 Weirton Steel Corp., 11 3/8%, sr. notes, 07/01/04 ................ B B2 1,000,000
500,000 Wheeling Pittsburgh Corp., 9 3/8%, sr. notes, 11/15/03 ........... BB- B1 475,000
------------
10,373,750
------------
OIL/NATURAL GAS/OIL SERVICES - 2.74%
1,000,000 Clark USA Inc., 10 7/8%, sr. notes, series B, 12/01/05 ........... B+ B2 1,030,000
436,000 HarCor Energy Inc., 14 7/8%, sr. notes, 07/15/02 ................. B- B3 518,840
750,000 NS Group Inc., 13 1/2%, units, 07/15/03 .......................... B- B3 750,938
300,000 Presidio Oil Co., 11 1/2%, sr. gas indexed notes, series B,
09/15/00 ....................................................... NR Caa 318,000
1,750,000 Trans Texas Gas Corp., 11 1/2%, sr. secd. notes, 06/15/02 ........ BB- B2 1,859,375
------------
4,477,153
------------
PACKAGING/CONTAINERS - 2.33%
500,000 Iron Mountain Inc., 10 1/8%, sr. sub. notes, 10/01/06 ............ B- B3 516,250
500,000 Pierce Leahy Corp., 11 1/8%, sr. sub. notes, 144A, 07/15/06 ...... B- B3 530,000
500,000 Portola Packaging Inc., 10 3/4%, sr. notes, 10/01/05 ............. B B2 523,125
500,000 Printpak Inc., 10 5/8%, sr. sub. notes, series A, 144A, 08/15/06 . NR B3 517,500
625,000 Sea Containers Ltd., 12 1/2%, sr. sub. deb., 12/01/04 ............ BB- B1 668,750
1,000,000 Stone Container Corp., 11 7/8%, sr. adj. rate notes, 144A,
08/01/16 ....................................................... B+ B1 1,052,500
------------
3,808,125
------------
PAPER/FOREST PRODUCTS/PRINTING - 2.54%
325,000 American Pad & Paper Company, 13%, sr. sub. notes, series B,
11/15/05 ....................................................... NR B3 376,187
500,000 Day International Group, Inc., 11 1/8%, sr. sub. notes, series B,
06/01/05 ....................................................... B- B3 522,500
1,000,000 FSW International Finance Co., 12 1/2%, gtd. secd. notes, 144A,
11/01/06 ....................................................... NR B1 1,000,000
250,000 Florida Coast Paper, 12 3/4%, 1st mtg. notes, 144A, 06/01/03 ..... B B3 243,750
1,000,000 Hayes Wheels International Inc., 11%, sr. sub. notes, 07/15/06 ... B B3 1,042,500
1,370,000 Wickes Lumber Co., 11 5/8%, sr. sub. notes, 12/15/03 ............. CCC+ B3 959,000
------------
4,143,937
------------
PERSONAL & MISCELLANEOUS SERVICES - 0.83%
750,000 ICON Health & Fitness, 13%, sr. sub. notes, 07/15/02 ............. CCC+ B3 847,500
500,000 Remington Product Co., 11%, sr. sub. notes, 144A, 05/15/06 ....... B- B3 502,500
------------
1,350,000
------------
PUBLIC UTILITY/ELECTRIC POWER/HYDRO POWER - 2.05%
1,000,000 Maxus Energy Corp., 11 1/2%, deb., 11/15/15 ...................... BB- B1 1,052,500
1,000,000 Midland Funding Corp. II, 13 1/4%, secd. lease oblig., 07/23/06 .. B- B2 1,147,500
325,000 Petroleum Heat & Power Inc., 12 1/4%, sub. deb., 02/01/05 ........ B+ B2 358,313
250,000 Rayovac Corp., 10 1/4%, sr. sub. notes, 144A, 11/01/06 ........... B- B3 253,750
500,000 Texas New Mexico Power Co., 12 1/2%, deb., 01/15/99 .............. B+ Ba3 542,500
------------
3,354,563
------------
RAIL/TRUCKING/OVERNIGHT DELIVERY - 2.19%
1,000,000 Ameritruck, 12 1/4%, sr. sub. notes, series B, 11/15/05 .......... B- Ba3 985,000
1,500,000 Petro PSC Properties, 12 1/2%, sr. notes, 06/01/02 ............... B B3 1,545,000
1,000,000 Terex Corp., 13 3/4%, sr. secd. notes, 05/15/02 .................. B- Caa 1,050,000
------------
3,580,000
------------
REAL ESTATE DEVELOPMENT/REITS/BUILDING/CONSTRUCTION - 4.18%
1,000,000 Associated Materials Inc., 11 1/2%, sr. sub. notes, 08/15/03 ..... B- B3 960,000
290,820 Bramalea Limited, 11 1/8%, deb., series 1, 03/22/98 (b) .......... NR NR 58,164
500,000 Greystone Homes Inc., 10 3/4%, gtd. sr. notes, 03/01/04 .......... B B1 502,500
1,000,000 MDC Holdings Inc., 11 1/8%, sr. notes, 12/15/03 .................. B+ NR 1,035,000
500,000 Oriole Homes Corp., 12 1/2%, sr. notes, 01/15/03 ................. B B2 465,000
750,000 Peters, J.M., Inc., 12 3/4%, sr. notes, 05/01/02 ................. B- B3 705,000
2,000,000 Ryland Group Inc., 10 1/2%, sr. notes, 07/01/06 .................. BB Ba2 2,040,000
1,000,000 Saul, B.F. Real Estate Investments, 11 5/8%, sr. secd. notes,
series B, 04/01/02 ............................................. B- NR 1,070,000
------------
6,835,664
------------
TELEPHONE/COMMUNICATIONS - 11.19%
500,000 Alvey Systems, Inc., 11 3/8%, sr. sub. notes, 01/31/03 ........... B- B3 521,250
800,000 American Communication Services, 12 3/4%, sr. disc. notes,
04/01/06 ....................................................... NR NR 420,000
2,000,000 Audio Vox Corp., 6 1/4%, conv. sub. deb., 03/15/01 ............... CCC+ Caa 1,720,000
250,000 Centennial Cellular Corporation, 10 1/8%, sr. notes, 05/15/05 .... B B2 243,750
750,000 Communications & Power Industries, Inc., 12%, sr. sub. notes,
08/01/05 ....................................................... NR B3 804,375
1,000,000 Dictaphone Corp., 11 3/4%, sr. sub. notes, 08/01/05 .............. B- B3 922,500
1,000,000 Echostar Communications Company, 12 7/8%, sr. secd. disc. notes,
06/01/04 ....................................................... NR B2 780,000
500,000 Fonorola Inc., 12 1/2%, sr. secd. notes, 08/15/02 ................ B+ B2 546,250
250,000 Gray Communications Systems Inc., 10 5/8, sr. sub. notes, 10/01/06 B- B3 255,625
500,000 Hyperion Telcommunications Inc., 13%, units, 04/15/03 ............ NR NR 305,000
2,000,000 IXC Communications Inc., 12 1/2%, sr. notes, series B, 10/01/05 .. NR B3 2,087,500
1,000,000 Intermedia Capital Partners IV, 11 1/4%, sr. disc. notes, 144A,
08/01/06 ....................................................... B B2 997,500
750,000 Intermedia Communications of Florida, Inc., 13 1/2%, sr. notes,
06/01/05 ....................................................... B- B3 847,500
500,000 Omnipoint Corp., 11 5/8%, sr. notes, 144A, 08/15/06 .............. CCC+ B2 505,000
2,000,000 Orbcomm Global L.P., 14%, sr. notes, 144A, 08/15/04 .............. B- B3 2,030,000
750,000 ProNet Inc., 11 7/8%, sr. sub. notes, 06/15/05 ................... CCC B3 686,250
1,000,000 Rogers Cantel Mobile Inc., 11 1/8%, gtd. sr. secd. notes, 07/15/02 BB- B2 1,057,500
350,000 Shared Technology Fairchild, 0%, sub. disc. notes, 03/01/06 ...... NR Caa 273,000
500,000 Sprint Spectrum L.P., 11%, sr. notes, 08/15/06 ................... B+ B2 508,750
1,500,000 Teleport Communications, 0%, sr. disc. notes, 07/01/07 ........... B B1 971,250
250,000 Tokheim Corp., 11 1/2%, sr. sub. notes, 144A, 08/01/06 ........... NR B3 262,500
500,000 Unisys Corp., 11 3/4%, sr. notes, 10/15/04 ....................... B+ B1 510,000
1,000,000 Unisys Corp., 12%, sr. notes, series B, 04/15/03 ................. B+ B1 1,022,500
------------
18,278,000
------------
TEXTILES/APPAREL - 0.64%
500,000 Synthetic Industries Inc., 12 3/4%, sr. sub. deb., 12/01/02 ...... NR B3 540,000
600,000 United States Leather, Inc., 10 1/4%, sr. notes, 07/31/03 ........ B- B3 507,000
------------
1,047,000
------------
TRANSPORTATION/AIRLINES/BUS - 1.40%
1,000,000 CHC Helicopter Corp., 11 1/2%, sr. sub. notes, 07/15/02 .......... B- B3 992,500
300,000 Greenwich Air Services Inc., 10 1/2%, sr. notes, 06/01/06 ........ B+ B2 315,000
1,000,000 Trans World Airlines Inc., 12%, sr. secd. reset notes, 11/03/98 .. NR NR 985,000
------------
2,292,500
------------
Total Fixed Income (cost $144,525,138) ........................... $146,256,199
------------
COMMON STOCK AND WARRANTS -- 5.07%
Value
Units Description (Note 2)
----- ----------- --------
1,000 Allmerica Financial Corp. ............................................................... $ 30,375
10,500 Ambassador Apartments Inc. .............................................................. 212,625
2,000 American Telecasting Inc., warrants ..................................................... 74,000
12,644 Amerisource Distribution Corp., class C ................................................. 526,307
185,900 Ames Department Stores Inc., excess cash flow pmt., series A ............................ 0
594,876 Ames Department Stores Inc., lit. trust units ........................................... 0
12,500 Bank Plus Corp. ......................................................................... 140,625
8,000 CHC Helicopter, warrants ................................................................ 0
5,925 Capital Pac Holdings Inc., warrants ..................................................... 22
1,000 Central Rents, warrants ................................................................. 0
750 Chattem Inc., warrants .................................................................. 3,000
33,000 Cort Business Services Corp., warrants .................................................. 99,000
500 County Seat Holdings Inc., warrants ..................................................... 0
20,000 Criimi Mae Inc., conv. preferred, series B .............................................. 540,000
2,000 Digex Inc. .............................................................................. 21,875
20,000 Excel Realty Trust Inc. ................................................................. 437,500
1,000 Eye Care Centers of America Inc., warrants .............................................. 10,000
40,000 Fidelity Federal Bank, exchangeable preferred ........................................... 1,120,000
10,000 First Alliance Co. ...................................................................... 272,500
6,000 Forest Oil Corp. ........................................................................ 90,000
500 HDA Management Corp., warrants .......................................................... 0
11,000 HarCor Energy Inc., warrants ............................................................ 0
20,000 Health & Retirement Properties Trust .................................................... 362,500
1,500 Heartland Wireless Communications, warrants ............................................. 22,500
10,000 Hospitality Properties Trust ............................................................ 260,000
500 Hyperion Telecom ........................................................................ 0
4,800 ICF Kaiser International Inc., warrants ................................................. 0
750 IHF Capital Inc., warrants .............................................................. 0
553 Insilco Corp., class B .................................................................. 21,567
750 Intermedia Communications of Florida, Inc. .............................................. 15,000
50,908 Live Entertainment Inc., conv. preferred, series B ...................................... 429,536
20,000 MDC Holdings Inc. ....................................................................... 147,500
500 Motels of America, 144A ................................................................. 500
20,000 National Propane Partners ............................................................... 397,500
1,000 Petro PSC Properties LP, warrants ....................................................... 33,000
132,000 Prime Retail Inc. ....................................................................... 1,534,500
10,000 R&G Financial Corp. ..................................................................... 198,750
1,000 Sabreliner Corp., warrants .............................................................. 0
500 Spanish Broadcasting Corp., warrants .................................................... 65,000
15,000 Supermarkets General Holdings, exchangeable preferred ................................... 405,000
15,000 Ugly Duckling Corp. ..................................................................... 236,250
9,800 Uniroyal Technology Corp., warrants ..................................................... 9,800
148,562 United Gas Holding Corp. (b) (c) ........................................................ 0
38,430 U.S. Trails ............................................................................. 39,631
20,000 Walden Residential Properties, conv. preferred, series B ................................ 525,000
1,500 Wireless One Inc., warrants ............................................................. 0
------------
TOTAL COMMON STOCK AND WARRANTS (cost $11,394,843) ...................................... 8,281,363
------------
TOTAL INVESTMENTS IN SECURITIES (cost $155,919,886) ..................................... 154,537,562
------------
OTHER ASSETS - 5.41% .................................................................... 8,843,936
------------
TOTAL ASSETS - 100% ..................................................................... 163,381,498
------------
<FN>
(a) Percentages indicated are based on total assets.
(b) Non-income producing security, currently in receivership.
(c) Security valued in good faith follolwing procedures approved by the Board of Directors.
(d) Pay in kind.
NR denotes not rated
</FN>
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<TABLE>
BALANCE SHEET
October 31, 1996
<S> <C>
ASSETS
Investments in securities at value (identified cost $155,919,886; see Schedule of
Investments and Note 2) $154,537,562
Cash ..................................................................................... 1,501,694
Receivables:
Investment securities sold ............................................................. 2,291,465
Receivable for fund shares sold ....................................................... 290,603
Interest ............................................................................... 4,591,445
Deferred debt issuance and organizational costs (Note 2) ................................. 9,998
Deferred auction agent fees (Note 6) ..................................................... 54,002
Prepaid surety bond premiums (Note 7) .................................................... 7,012
Prepaid insurance ........................................................................ 23,174
Other assets ............................................................................. 74,543
------------
Total assets ..................................................................... $163,381,498
------------
LIABILITIES
Payables:
Investment securities purchased ........................................................ $ 1,795,622
Accrued expenses (Note 3) ................................................................ 875,236
Senior notes (Note 4) .................................................................... 20,000,000
------------
Total liabilities ................................................................ $ 22,670,858
------------
Net Assets:
Taxable auction rate preferred stock, no par value --
Authorized -- 1,000 shares
Issued -- 200 shares, liquidation preference of $100,000 per share (Notes 5 and 7) ... $ 20,000,000
------------
Common stock, $.01 par value --
Authorized -- 100,000,000 shares
Issued and outstanding -- 30,937,330 shares .......................................... $ 309,373
Capital in excess of par value (Notes 2 and 5) ......................................... 185,160,682
Accumulated undistributed net investment income (Note 2) ............................... 2,018,708
Accumulated net realized loss from security transactions ............................... (65,395,798)
Net unrealized depreciation of investments ............................................. (1,382,324)
------------
Net assets applicable to common stock (equivalent to $3.90 per share, based on
30,937,330 shares outstanding) ................................................. $120,710,641
------------
Total net assets ............................................................. $140,710,641
============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<TABLE>
STATEMENT OF OPERATIONS
For the year ended October 31, 1996
<S> <C>
INVESTMENT INCOME (Note 2):
Interest income ........................................................................ $14,924,640
Dividend income ........................................................................ 366,251
Accretion of discount .................................................................. 1,509,541
-----------
Total investment income .......................................................... $16,800,432
-----------
EXPENSES:
Interest expense ....................................................................... $ 1,305,999
Investment advisory fee (Note 3) ....................................................... 928,792
Custodian and transfer agent fees ...................................................... 169,999
Preferred dividend auction costs ....................................................... 151,001
Professional fees ...................................................................... 165,002
Miscellaneous expenses ................................................................. 141,831
Amortization of prepaid surety bond premiums (Note 7) .................................. 80,001
Directors' fees ........................................................................ 94,289
Insurance expense ...................................................................... 107,774
Amortization of deferred auction agent fees (Note 6) ................................... 26,999
-----------
Total expenses ................................................................... $ 3,171,687
-----------
Net investment income ............................................................ $13,628,745
-----------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized gain on investments sold .................................................. $ 351,405
Change in net unrealized depreciation of investments (Note 2) .......................... 5,074,470
-----------
Net realized and unrealized gain on investments .................................. $ 5,425,875
-----------
Net increase in net assets resulting from operations ............................. $19,054,620
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS ($5,679 per share) ............................... (1,135,736)
-----------
Net increase in net assets applicable to common stockholders ..................... $17,918,884
===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
STATEMENT OF CASH FLOWS
For the year ended October 31, 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest and dividends received .......................... $ 14,909,511
Operating expenses paid .................................. (3,209,152)
-------------
Net cash provided by operating activities .......... $ 11,700,359
-------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of portfolio securities ........................ $(171,846,771)
-------------
Sales and maturities of portfolio securities ............. 153,286,680
-------------
Net cash used in investing activities .............. $ (18,560,091)
--------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from common stock rights offering and sale of
common stock ........................................... 19,553,840
Preferred stock dividends paid ........................... (1,121,403)
Common stock dividends paid from operations .............. (10,071,059)
-------------
Net cash provided by financing activities .......... $ 8,361,378
-------------
NET INCREASE IN CASH ....................................... $ 1,501,646
Cash, beginning of period .................................. 48
-------------
CASH, END OF PERIOD ........................................ $ 1,501,694
=============
RECONCILIATION OF NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Net increase in net assets resulting from operations ... $ 19,054,620
Increase in interest and other receivables ............. (616,300)
Amortization of Fidelity Bond and other deferred assets 32,180
Increase in other assets ............................... 6,923
Increase in accrued expenses ........................... (76,568)
Net realized gain on investments sold .................. (351,405)
Change in net unrealized depreciation of investments ... (5,074,470)
Accretion of bond discount ............................. (1,274,621)
-------------
Net cash provided by operating activities .......... $ 11,700,359
=============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest ................. $ 1,306,000
=============
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<TABLE>
STATEMENT OF CHANGES IN NET ASSETS
<CAPTION>
Fiscal Year Ended Fiscal Year Ended
October 31, October 31,
1996 1995
----------------- -----------------
<S> <C> <C>
FROM OPERATIONS:
Net investment income ........................................ $ 13,628,745 $ 12,374,147
Net realized gain/(loss) on investments sold ................. 351,405 (3,741,007)
Change in net unrealized depreciation of investments ......... 5,074,470 3,492,305
------------ ------------
Net increase in net assets resulting from operations ... $ 19,054,620 $ 12,125,445
------------ ------------
FROM FUND SHARE TRANSACTIONS:
Shares issued (353,455 shares and 225,487 shares,
respectively) to common stockholders for reinvestment of
dividends .................................................. $ 1,333,077 $ 827,802
Net proceeds from sale of common stock issued (5,393,885
shares, after deducting $996,862 of soliciting fees and
other expenses) ............................................ 19,553,840 --
------------ ------------
Increase in net assets resulting from fund share
transactions ......................................... $ 20,886,917 $ 827,802
------------ ------------
DISTRIBUTIONS TO STOCKHOLDERS:
Preferred dividends ($5,679 and $5,996 per share, respectively) $ (1,135,736) $ (1,199,291)
Common dividends ($.42 and $.42 per share, respectively) from
operations ................................................. (11,404,136) (10,516,741)
------------ ------------
Decrease in net assets resulting from distributions to
stockholders ......................................... (12,539,872) (11,716,032)
------------ ------------
Total net increase in net assets ....................... $ 27,401,665 $ 1,237,215
NET ASSETS:
Beginning of period .......................................... 113,308,976 112,071,761
------------ ------------
End of period (including $2,018,708 and $929,835 of
undistributed net investment income as of October 31, 1996
and 1995, respectively) .................................... $140,710,641 $113,308,976
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<TABLE>
FINANCIAL HIGHLIGHTS
SELECTED PER SHARE DATA AND RATIOS
FOR EACH SHARE OF COMMON STOCK OUTSTANDING THROUGHOUT THE PERIODS PRESENTED
<CAPTION>
For the Years Ended October 31,
------------------------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period ................ $ 3.70 $ 3.69 $ 4.25 $ 4.03 $ 3.89
-------- -------- ------- ------- -------
Net investment income ............................... .50# .45 .48# .63# .62
Net realized and unrealized gain (loss) on
investments ....................................... .20# .03 (.38)# .39# .07
-------- -------- ------- ------- -------
Total from investment operations ............ $ .70 $ .48 $ .10 $ 1.02 $ .69
-------- -------- ------- ------- -------
Distributions:
Dividends from accumulated net
investment income
To preferred stockholders ....................... (.04) (.05) (.03) (.06) (.10)
To common stockholders .......................... (.42) (.42) (.45) (.62) (.45)
-------- -------- ------- ------- -------
Total distributions ......................... $ (.46) $ (.47) $ (.48) $ (.68) $ (.55)
-------- -------- ------- ------- -------
Effect of sale of common stock and related
expenses from rights offering ..................... $ (.04) $ -- $ (.18) $ (.12) $ --
-------- -------- ------- ------- -------
Net asset value, end of period ...................... $ 3.90 $ 3.70 $ 3.69 $ 4.25 $ 4.03
======== ======== ======= ======= =======
Per share market value, end of period ............... $ 4.00 $ 3.88 $ 3.50 $ 4.25 $ 4.00
======== ======== ======= ======= =======
Total investment return ............................. 15.29% 28.57% (7.78)% 23.25% 27.99%
======== ======== ======= ======= =======
Net assets, end of period, applicable to
common stock (a) .................................. $120,711 $ 93,309 $92,072 $79,438 $55,178
======== ======== ======= ======= =======
Net assets, end of period, applicable to
preferred stock (a) ............................... $ 20,000 $ 20,000 $20,000 $20,000 $30,000
======== ======== ======= ======= =======
Net assets, end of period (a) ....................... $140,711 $113,309 $112,072 $99,438 $85,178
======== ======== ======= ======= =======
Ratio of operating expenses to average net assets** . 2.21%+ 2.28%+ 2.30%+ 2.13%+ 2.28%+
Ratio of net investment income to average net
assets** .......................................... 9.51% 9.39% 8.64% 9.26% 9.33%
Portfolio turnover rate ............................. 108.33% 80.71% 72.00% 117.20% 97.86%
<FN>
(a) Dollars in thousands.
** Ratios calculated on the basis of expenses and net investment income applicable to both the common and preferred shares relative
to the average net assets of both the common and preferred shareholders.
+ Excluding interest expense, the ratio of operating expenses to average net assets is 1.30%, 1.29%, 1.32%, 1.50% and 1.72%,
respectively.
# Calculation is based on average shares outstanding during the indicated period due to the per share effect of the Fund's rights
offerings.
</FN>
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<TABLE>
INFORMATION REGARDING SENIOR SECURITIES
<CAPTION>
As of October 31,
-----------------------------------------------------------------------
1996 1995 1994 1993 1992
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total Amount Outstanding:
Notes $20,000,000 $20,000,000 $20,000,000 $20,000,000 $ 5,000,000
Preferred stock 20,000,000 20,000,000 20,000,000 20,000,000 30,000,000
Asset Coverage:
Per note (a) 690% 667% 660% 597% 1,804%
Per preferred stock share (b) 345% 333% 330% 299% 258%
Involuntary Liquidation Preference:
Per preferred stock share (c) $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000
Approximate Market Value:
Per note $ 990.00 $ 987.50 $ 937.10 $ 997.50 $ 1,087.50
Per preferred stock share 100,000 100,000 100,000 100,000 100,000
<FN>
(a) Calculated by subtracting the Fund's total liabilities (not including senior securities) from the Fund's total assets and
dividing such amount by the principal amount of the debt outstanding.
(b) Calculated by subtracting the Fund's total liabilities (not including senior securities) from the Fund's total assets and
dividing such amount by the principal amount of the debt outstanding and aggregate liquidation preference of the outstanding
shares of Taxable Auction Rate Preferred Stock.
(c) Plus accumulated and unpaid dividends.
</FN>
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1996
(1) ORGANIZATION AND OPERATIONS
Prospect Street High Income Portfolio Inc. (the "Fund") was organized as a
corporation in the state of Maryland on May 13, 1988 and is registered with the
Securities and Exchange Commission as a diversified, closed-end, management
investment company under the Investment Company Act of 1940. The Fund commenced
operations on December 5, 1988. The Fund's financial statements have been
prepared in conformity with generally accepted accounting principles, which
requires the management of the Fund 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 income and expenses during the reporting periods. Actual
results could differ from those estimates. The following is a summary of
significant accounting policies consistently followed by the Fund, which are in
conformity with those generally accepted in the investment company industry.
The Fund invests primarily in securities of fixed-maturity, corporate debt
securities and in redeemable preferred stocks that are rated less than
investment grade. Risk of loss upon default by the issuer is significantly
greater with respect to such securities compared to investment-grade securities
because these securities are generally unsecured and are often subordinated to
other creditors of the issuer, and because these issuers usually have high
levels of indebtedness and are more sensitive to adverse economic conditions,
such as a recession, than are investment-grade issuers. In some cases, the
collection of principal and timely receipt of interest is dependent upon the
issuer attaining improved operating results, selling assets or obtaining
additional financing.
See the schedule of investments for information on individual securities, as
well as industry diversification and credit quality ratings.
(2) SIGNIFICANT ACCOUNTING POLICIES
(A) VALUATION OF INVESTMENTS
Investments for which listed market quotations are readily available are
stated at market value, which is determined using the last reported sale price
or, if no sales are reported, as in the case of some securities traded
over-the-counter, the last reported bid price. Short-term investments having
remaining maturities of 60 days or less are stated at amortized cost, which
approximates market.
Other investments, primarily noninvestment-grade corporate debt securities for
which market quotations are not readily available due to a thinly traded market
with a limited number of market makers, are stated at fair value on the basis of
valuations furnished by an independent pricing service, subject to adjustment by
the investment adviser in certain circumstances. The independent pricing service
determines value based primarily on quotations from dealers and brokers, market
transactions, accessing data from quotation services, offering sheets obtained
from dealers and various relationships between securities. The independent
pricing service utilizes the last sales price based on odd-lot trades, if
available. If such price is not available, the price furnished is based on
round-lot or institutional size trades. These procedures have been approved by
the Board of Directors.
The fair value of restricted securities is determined by the investment
adviser following procedures approved by the Board of Directors.
(B) SECURITY TRANSACTIONS AND RELATED INVESTMENT INCOME
Realized gains and losses on investments sold are recorded on the
identified-cost basis. Interest income is recorded on the accrual basis.
(C) FEDERAL INCOME TAXES
It is the Fund's policy to comply with the requirements of the Internal
Revenue Code of 1986, as amended, applicable to regulated investment companies,
and to distribute substantially all of its investment company taxable income to
its stockholders each year. Accordingly, no federal income tax provision is
required. The Fund has reclassified $112,828 from capital in excess of par to
accumulated undistributed net investment income. This reclassification has no
impact on the net asset value of the Fund and is designed to present the Fund's
capital accounts on a tax basis.
At October 31, 1996, the cost of investments in securities for federal income
tax purposes was $155,950,435. Aggregate gross unrealized gains on securities in
which there was an excess of market value over tax cost was $6,609,451.
Aggregate gross unrealized losses on securities in which there was an excess of
tax cost over market value was $7,704,835. The net unrealized loss on securities
held by the Fund was $1,095,384 for federal income tax purposes.
At October 31, 1996, the Fund had the following capital loss carryovers
available to offset future capital gains, if any, to the extent provided by
regulations:
CARRYOVER
AVAILABLE EXPIRATION DATE
$(42,317,344) October 31, 1998
(18,529,051) October 31, 1999
(808,396) October 31, 2002
(3,703,531) October 31, 2003
------------
$(65,358,322)
============
(D) COMMON STOCK AND TAXABLE AUCTION RATE PREFERRED STOCK (PREFERRED STOCK),
OFFERING AND DEFERRED DEBT ISSUANCE AND ORGANIZATIONAL COSTS
The costs incurred by the Fund in connection with the initial sale of the
common and preferred stock as well as the common stock rights offerings have
been recorded as a reduction of the common stock proceeds. The costs incurred by
the Fund in connection with the issuance of the senior notes have been deferred
and are being amortized on a straight-line basis over a period of five years.
(E) CASH FLOW INFORMATION
The Fund invests primarily in corporate debt securities and distributes
dividends from net investment income, which are paid in cash or shares of common
stock of the Fund. These activities are reported in the accompanying statement
of changes in net assets, and additional information on cash receipts and cash
payments is presented in the accompanying statement of cash flows.
(3) INVESTMENT ADVISORY AGREEMENT
Prospect Street Investment Management Co., Inc., the Fund's Investment
Adviser, earned approximately $928,792 in management fees for the year ended
October 31, 1996. Management fees paid by the Fund to the Investment Adviser
were calculated at .65% (on an annual basis) of the average weekly value of
total assets of the Fund less accrued liabilities (excluding the principal
amount of the notes and the liquidation preference of the preferred stock and
including accrued and unpaid dividends on the preferred stock) up to and
including $175,000,000 of net assets, .55% on the next $50,000,000 of net assets
and .50% of the excess of net assets over $225,000,000. At October 31, 1996, the
fee payable to the Investment Adviser was $114,157, which was included in
accrued expenses in the accompanying balance sheet. However, for a period of one
year commencing on the expiration date of the rights offering (Note 12), the
Adviser will waive its advisory fee with respect to any increase in the Fund's
net assets resulting from the exercise of any rights pursuant to the Offer.
(4) DEBT
In July 1993, the Fund repurchased the remaining $5,000,000 (principal amount)
of its senior extendible notes (the Notes), which carried an annual interest
rate through November 30, 1993 of 10.28%. The Fund simultaneously issued
$20,000,000 of new Senior Notes (the Senior Notes) that will mature, if not
previously redeemed, on December 1, 1998. The Fund is required to maintain
certain asset coverages with respect to the Senior Notes, as defined in the Note
Purchase Agreement, and the Senior Notes are subject to mandatory redemption if
the Fund fails to maintain these asset coverages. The Senior Notes bear interest
at the rate of 6.53% per annum through November 30, 1998. Interest on the Senior
Notes is due every June 1 and December 1, commencing December 1, 1993.
The Senior Notes are redeemable, in whole or in part, by the Fund at certain
times and under certain circumstances, as defined in the Note Purchase
Agreement.
(5) REDEEMABLE PREFERRED STOCK
In July 1993, the Fund redeemed 100 of the 300 shares of preferred stock that
were issued concurrently with the issuance of the Senior Extendible Notes.
Dividends are cumulative at a rate that was established at the offering of the
preferred stock and which has and will continue to be reset every 30 days
thereafter by an auction. Dividend rates ranged from 5.316% to 6.000% of the
liquidation preference during the year ended October 31, 1996. The remaining 200
shares of preferred stock are redeemable, at the option of the Fund, at a
redemption price equal to $100,000 per share, plus accumulated and unpaid
dividends, on any dividend payment date. The preferred stock is also subject to
mandatory redemption at a redemption price equal to $100,250 per share, plus
accumulated and unpaid dividends, if the Fund is in default of its surety asset
coverage requirements with respect to the preferred stock (see Note 7). In
general, the holders of the preferred stock and the common stock vote together
as a single class, except that the holders of the preferred stock, as a separate
class, vote to elect two members of the Board of Directors, and separate class
votes are required on certain matters that affect the respective interests of
the preferred stock and common stock. The preferred stock has a liquidation
preference of $100,000 per share, plus accumulated and unpaid dividends. The
Fund is required to maintain certain asset coverages with respect to the
preferred stock, as defined in the Fund's Note Purchase Agreement and Surety
Bond Agreement.
(6) AUCTION AGENT
The Fund amended and extended the auction agent agreement with Bear Stearns &
Co. Inc. on October 26, 1993 (which was originally dated May 7, 1990) to provide
for an extension to December 4, 1998. The Fund incurred additional costs of
$135,000 related to extending this agreement. These costs are being amortized on
a straight-line basis over the remaining life of the extended agreement.
Amortization expense for the year ended October 31, 1996 was $26,999.
(7) SURETY BOND
The Fund has entered into an insurance agreement, dated as of December 1,
1988, with Financial Security Assurance, Inc. (FSA), pursuant to which FSA has
issued a surety bond. Under the terms of the surety bond, FSA has
unconditionally and irrevocably guaranteed dividend, redemption and liquidation
payments to preferred shareholders upon failure of the Fund to do so, and the
Fund is then obligated to reimburse FSA for any amounts paid under the surety
bond. The surety bond had an initial term of five years and was scheduled to
expire on December 5, 1993. On July 15, 1993, the Fund extended the terms of the
surety bond from December 5, 1993 to December 5, 1998. The Fund will pay an
annual premium of 0.40% on the maximum aggregate liquidation preference of the
preferred stock.
The Fund executed an amendment to the insurance agreement on April 11, 1990,
which provides that the Fund must redeem or repurchase all of the then
outstanding shares of preferred stock in the event that the dividend rate on the
preferred stock for the period next succeeding the auction in September 1998 is
the maximum applicable rate (as defined) payable on the Fund's preferred stock.
(8) PURCHASES AND SALES OF SECURITIES
For the year ended October 31, 1996, the aggregate cost of purchases and
proceeds from sales of investment securities other than U.S. Government
obligations and short-term investments aggregated $171,129,613 and $148,033,672,
respectively. There were no purchases or sales of U.S. Government obligations
during the year ended October 31, 1996.
(9) CERTAIN TRANSACTIONS
Certain officers of the Investment Adviser serve on the Board of Directors of
the Fund. They receive no compensation in this capacity.
Directors who are not officers or employees of the Investment Adviser receive
a fee of $10,000 per year plus $2,000 per Directors' meetings attended, together
with actual out-of-pocket expenses relating to attendance at such meetings and
$1,000 per telephone meeting. In addition, members of the Fund's audit
committee, which consists of certain of the Fund's noninterested Directors,
receive $1,000 per audit committee meeting attended, if held on a day other than
the day of a Directors' meeting, together with actual out-of-pocket expenses
relating to attendance at such meeting.
(10) DIVIDENDS AND DISTRIBUTIONS
The Board of Directors of the Fund declared regular dividends on the common
stock of $.035 per share payable on November 30 and December 29, 1995, and
January 31, February 29, March 29, April 30, May 31, June 28, July 31, August
30, September 30 and October 31, 1996.
Distributions on common stock are declared based on annual projections of the
Fund's net investment income (defined as dividends and interest income, net of
Fund expenses, less distributions on the preferred stock). The Fund plans to pay
monthly distributions to common shareholders. Meanwhile, as a result of market
conditions or investment decisions, the amount of distributions may exceed net
investment income earned at certain times throughout the period. It is
anticipated that, on an annual basis, the amount of distributions to common
shareholders will not exceed net investment income (as defined) applicable to
common shareholders on a tax basis. All shareholders of the Fund are
automatically considered a participant in the Dividend Reinvestment Plan (the
"Plan") unless otherwise elected. Under the Plan, when the market price of
common stock shares is equal to or exceeds the net asset value on record date
for distribution, participants will receive all dividends and distributions in
full and fractional shares of the Fund at the most recently determined net asset
value but in no event less than 95% of market price. If on record date for
distributions the net asset value of the common stock exceeds its market price,
or if the Fund shall declare a dividend or capital gains distribution payable
only in cash, the dividend-paying agent will buy common stock in the open market
for the participants' accounts. Participants are not charged a service fee for
the Plan but are subject to a pro rata share of brokerage fees incurred with
respect to open market purchases of common stock.
(11) FAIR VALUE OF LONG-TERM DEBT
The fair value of the Fund's long-term debt is estimated based on the quoted
market prices for the same issues or on the current rates offered to the Fund
for debt of the same remaining securities. At October 31, 1996, the fair value
of the Senior Notes was $19,800,000.
(12) RIGHTS OFFERING
On May 10, 1996 the Fund commenced a rights offering whereby the Fund issued
to its shareholders of record, as of that date, transferable rights entitling
the holders thereof to subscribe for an aggregate of 8,840,000 shares of the
Fund's common stock. Each record date shareholder had the ability to receive one
right for each three shares of common stock held. Each right allowed the rights
holder to subscribe for one share of common stock. The subscription period for
the rights offering expired on June 21, 1996 and the Fund issued 5,393,885
shares of common stock at $3.81 per share. Proceeds to the Fund amounted to
$19,553,840, net of soliciting fees and offering expenses of $996,862.
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
Prospect Street High Income Portfolio Inc.:
We have audited the accompanying balance sheet of PROSPECT STREET HIGH
INCOME PORTFOLIO INC., including the schedule of investments, as of October 31,
1996, the related statements of operations and cash flows for the year then
ended, the statements of changes in net assets for the year ended October 31,
1996 and the year ended October 31, 1995 and the financial highlights for the
periods presented. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of investments owned as of
October 31, 1996 by correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Prospect Street High Income Portfolio Inc. as of October 31, 1996, and the
results of its operations, the changes in its net assets, its cash flows and the
financial highlights for the periods presented, in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
December 13, 1996
<PAGE>
<TABLE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
<C> <C>
INVESTMENT ADVISER AUDITORS
Prospect Street Investment Management Co., Inc. Arthur Andersen LLP
60 State Street, Suite 3750 Boston, MA
Boston, MA 02109
TRANSFER AND SHAREHOLDERS' SERVICING AGENT
OFFICERS State Street Bank and Trust Company
Richard E. Omohundro, Jr. -- President P.O. Box 8200
John A. Frabotta -- Vice President, Boston, MA 02266
Treasurer and (800) 426-5523
Chief Investment
Officer CUSTODIAN
Karen J. Thelen -- Secretary State Street Bank and Trust Company
Boston, MA
DIRECTORS
John S. Albanese PAYING AGENT (PREFERRED)
C. William Carey Bankers Trust Company
Joseph G. Cote New York, NY
John A. Frabotta
Richard E. Omohundro, Jr. Listed: NYSE
Harlan D. Platt Symbol: PHY
Christopher E. Roshier
LEGAL ADVISER
Olshan Grundman Frome & Rosenzweig LLP
New York, NY
</TABLE>
<PAGE>
FACTS FOR SHAREHOLDERS:
Prospect Street High Income Portfolio Inc. is listed on the New York Stock
Exchange under the symbol "PHY". The Wall Street Journal publishes Friday's
closing net asset value of the Fund every Monday and lists the market price of
the Fund daily.
QUESTIONS REGARDING YOUR ACCOUNT: Please telephone State Street Bank & Trust
Company at their toll free number 1-800-426-5523 Monday through Friday from
9:00 a.m. to 5:00 p.m.
WRITTEN CORRESPONDENCE REGARDING YOUR ACCOUNT: Please mail all correspondence
directly to Prospect Street High Income Portfolio Inc., c/o State Street Bank &
Trust Company, P.O. Box 8200, Boston, MA 02266. For express mail the address is
Prospect Street High Income Portfolio Inc., c/o State Street Bank & Trust
Company, 2 Heritage Drive, Corporate Stock Transfer -- 4th Floor, North Quincy,
MA 02171.
<PAGE>
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
60 State Street, Suite 3750
Boston, MA 02109
PROSPECT STREET(R)
HIGH INCOME PORTFOLIO INC.
ANNUAL
REPORT
OCTOBER 31, 1996
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