FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended June 30, 1998 or
Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number: 0-16497
CAPITAL SOURCE L.P.
(Exact name of registrant as specified in its charter)
Delaware 52-1417770
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
Suite 400, 1004 Farnam Street, Omaha, Nebraska 68102
(Address of principal executive offices) (Zip Code)
(402) 444-1630
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
<PAGE> - i -
Part I. Financial Information
Item 1. Financial Statements
CAPITAL SOURCE L.P.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
June 30, 1998 Dec. 31, 1997
--------------- ---------------
<S> <C> <C>
Assets
Investment in real estate:
Land $ 3,093,671 $ 3,093,671
Buildings 35,536,966 35,536,966
Personal property 2,008,106 2,001,950
--------------- ---------------
40,638,743 40,632,587
Less accumulated depreciation (11,280,573) (10,831,199)
--------------- ---------------
Net investment in real estate 29,358,170 29,801,388
Cash and temporary cash investments, at cost
which approximates market value (Note 5) 10,053,718 10,410,564
Escrow deposits and property reserves 823,053 894,986
Investment in mortgage-backed securities (Note 5) 967,089 1,088,526
Interest and other receivables 234,069 70,542
Deferred mortgage issuance costs, net of accumulated amortization of
$1,573,779 in 1998 and $1,503,039 in 1997 2,029,027 2,099,768
Other assets 1,009,631 767,156
--------------- ---------------
$ 44,474,757 $ 45,132,930
=============== ===============
Liabilities and Partners' Capital (Deficit)
Liabilities
Accounts payable and accrued expenses $ 1,509,616 $ 1,532,202
Distribution payable (Note 3) 860,587 860,587
Mortgage loan payable (Note 7) 6,320,076 6,320,076
Due to general partners and their affiliates (Note 4) 3,961,726 4,013,626
--------------- ---------------
12,652,005 12,726,491
--------------- ---------------
Minority interest 191,960 192,296
--------------- ---------------
Partners' Capital (Deficit)
General Partners (299,350) (293,517)
Limited Partners ($9.46 per BAC in 1998 and $9.63 in 1997) 31,930,142 32,507,660
--------------- ---------------
31,630,792 32,214,143
--------------- ---------------
$ 44,474,757 $ 45,132,930
=============== ===============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
<PAGE> - 1 -
CAPITAL SOURCE L.P.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
For the For the For the Six For the Six
Quarter Ended Quarter Ended Months Ended Months Ended
June 30, 1998 June 30, 1997 June 30, 1998 June 30, 1997
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Income
Rental income $ 1,882,620 $ 1,874,301 $ 3,777,402 $ 3,701,485
Mortgage-backed securities income 18,554 23,110 38,449 47,355
Interest on temporary cash investments 139,402 141,384 280,690 284,747
Other income 99,083 63,082 176,962 153,106
--------------- --------------- --------------- ---------------
2,139,659 2,101,877 4,273,503 4,186,693
--------------- --------------- --------------- ---------------
Expenses
Real estate operating expenses 978,062 1,065,971 1,928,918 1,885,371
Depreciation 224,688 224,393 449,374 448,785
Interest expense 148,844 149,841 298,685 299,682
General and administrative expenses (Note 4)
Investor servicing 148,042 86,992 274,604 173,129
Professional fees 11,895 14,750 24,670 30,600
Other expenses 19,756 707 86,352 2,272
Amortization 35,371 34,199 70,740 68,398
--------------- --------------- --------------- ---------------
1,566,658 1,576,853 3,133,343 2,908,237
--------------- --------------- --------------- ---------------
Minority interest in losses of Operating
Partnerships 248 4,653 390 9,502
--------------- --------------- --------------- ---------------
Net income $ 573,249 $ 529,677 $ 1,140,550 $ 1,287,958
=============== =============== =============== ===============
Net income allocated to:
General Partners $ 5,733 $ 5,297 $ 11,406 $ 12,880
Limited Partners 567,516 524,380 1,129,144 1,275,078
--------------- --------------- --------------- ---------------
$ 573,249 $ 529,677 $ 1,140,550 $ 1,287,958
=============== =============== =============== ===============
Net income, basic and diluted, per BAC $ .16 $ .16 $ .33 $ .38
=============== =============== =============== ===============
</TABLE>
CAPITAL SOURCE L.P.
CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL (DEFICIT)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
General Limited
Partners Partners Total
--------------- --------------- ---------------
<S> <C> <C> <C>
Partners' Capital (Deficit) (excluding net unrealized holding gains)
Balance at December 31, 1997 $ (293,953) $ 32,464,480 $ 32,170,527
Net income 11,406 1,129,144 1,140,550
Cash distributions paid or accrued (Note 3) (17,212) (1,703,982) (1,721,194)
--------------- --------------- ---------------
(299,759) 31,889,642 31,589,883
--------------- --------------- ---------------
Net unrealized holding gains
Balance at December 31, 1997 436 43,180 43,616
Net change (27) (2,680) (2,707)
--------------- --------------- ---------------
409 40,500 40,909
--------------- --------------- ---------------
Balance at June 30, 1998 $ (299,350) $ 31,930,142 $ 31,630,792
=============== =============== ===============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
<PAGE> - 2 -
CAPITAL SOURCE L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
For the Six For the Six
Months Ended Months Ended
June 30, 1998 June 30, 1997
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities
Net income $ 1,140,550 $ 1,287,958
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 520,114 517,183
Amortization of discount on mortgage-backed securities (1,313) (1,134)
Minority interest in losses of Operating Partnerships (390) (9,502)
Increase in interest and other receivables (163,527) (159,247)
Decrease in escrow deposits and property reserves 71,933 95,540
Decrease (increase) in other assets (242,420) 109,560
Decrease in accounts payable and accrued expenses (22,586) (121,062)
Decrease in due to general partners and their affiliates (51,900) (62,640)
--------------- ---------------
Net cash provided by operating activities 1,250,461 1,656,656
--------------- ---------------
Cash flows from investing activities
Principal payments received on mortgage-backed securities 120,043 103,702
Acquisition of personal property (6,156) (3,513)
--------------- ---------------
Net cash provided by investing activities 113,887 100,189
--------------- ---------------
Cash flow used in financing activity
Distributions (1,721,194) (1,721,194)
--------------- ---------------
Net increase (decrease) in cash and temporary cash investments (356,846) 35,651
Cash and temporary cash investments at beginning of period 10,410,564 10,272,497
--------------- ---------------
Cash and temporary cash investments at end of period $ 10,053,718 $ 10,308,148
=============== ===============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 298,685 $ 299,682
=============== ===============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
<PAGE> - 3 -
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
1. Organization
Capital Source L.P. (the Partnership) was formed on August 22, 1985, under the
Delaware Revised Uniform Limited Partnership Act. The General Partners of
the Partnership are Insured Mortgage Equities, Inc. and America First Capital
Source I L.L.C. (the General Partners).
The Partnership provided virtually 100% of the debt and equity financing for
eight multifamily rental housing properties. The Partnership's investment in
the properties consisted of: (i) approximately 85% in the form of permanent
mortgages and/or loans to fund construction; and, (ii) the balance to purchase
up to a 99% limited partnership interest in the Operating Partnerships which
developed, own and operate the properties. Each loan is insured or
guaranteed, in an amount substantially equal to the face amount of the
mortgage, by the Federal Housing Administration (FHA) or the Government
National Mortgage Association (GNMA). The Partnership has been repaid by FHA
on one of its first mortgage loans. The Partnership has also been repaid by
GNMA on one of its GNMA Certificates. The Partnership no longer holds a
Partnership Equity Investment in the Operating Partnership which owned the
property collateralizing the repaid GNMA Certificate. The seven remaining
Operating Partnerships are geographically located as follows: (i) two in
North Carolina; and, (ii) one each in Ohio, Florida, Michigan, Virginia and
Illinois.
CS Properties I, Inc., which is owned by affiliates of the General Partners,
serves as the Special Limited Partner for the Operating Partnerships. The
Special Limited Partner has the power, among other things, to remove the
general partners of the Operating Partnerships under certain circumstances and
to consent to the sale of the Operating Partnerships' assets. CS Properties
I, Inc. also serves as the general partner of Misty Springs Apartments,
Waterman's Crossing and Fox Hollow Apartments.
The Partnership will terminate subsequent to the sale of all properties but in
no event will the Partnership continue beyond December 31, 2030.
2.Summary of Significant Accounting Policies
A) Financial Statement Presentation
The consolidated financial statements include the accounts of the
Partnership and seven subsidiary Operating Partnerships. The Partnership
is a limited partner with an ownership interest of up to 99% in six of
the subsidiary Operating Partnerships. The Partnership's ownership
interest in The Ponds at Georgetown L.P. is 30.29%. The remaining limited
partner interest of 68.70% is owned by Capital Source II L.P.-A, an
affiliate of the General Partners. All significant intercompany accounts
and transactions have been eliminated in consolidation.
The consolidated financial statements are prepared without audit on the
accrual basis of accounting in accordance with generally accepted
accounting principles. The consolidated financial statements should be
read in conjunction with the consolidated financial statements and notes
thereto included in the Partnership's Annual Report on Form 10-K for the
year ended December 31, 1997. In the opinion of management, all normal
and recurring adjustments necessary to present fairly the financial
position at June 30, 1998 and results of operations for all periods
presented have been made.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
<PAGE> - 4 -
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
B) Investment in Real Estate
The Partnership's investment in real estate is carried at cost less
accumulated depreciation. The carrying value of each property is reviewed
for impairment whenever events or circumstances indicate that the carrying
value may not be recoverable. If the sum of the expected undiscounted
future cash flows is less than the carrying amount, an impairment is
recorded based on fair value.
C) Investment in Mortgage-Backed Securities
Investment securities are classified as held-to-maturity,
available-for-sale or trading. Investments classified as
available-for-sale are reported at fair value with any unrealized gains or
losses excluded from earnings and reflected as a separate component of
partners' capital. Subsequent increases and decreases in the net
unrealized gain/loss on the available-for-sale securities are reflected as
adjustments to the carrying value of the portfolio and adjustments to the
component of partners' capital. The Partnership does not have investment
securities classified as held-to-maturity or trading.
D) Depreciation and Amortization
Depreciation of real estate is based on the estimated useful life of the
properties using the straight-line method. Deferred mortgage issuance
costs are amortized using the effective yield method over the 40 year term
of the respective loan.
E) Revenue Recognition
The Operating Partnerships lease multifamily rental units under
operating leases with terms of one year or less. Rental revenue is
recognized as earned, net of any vacancy losses and rental concessions
offered.
F) Income Taxes
No provision has been made for income taxes since BAC Holders are required
to report their share of the Partnership's income for federal and state
income tax purposes.
G) Temporary Cash Investments
Temporary cash investments are invested in short-term debt securities
purchased with original maturities of three months or less.
H) Net Income per Beneficial Assignment Certificate (BAC)
Net income per BAC is based on the number of BACs outstanding (3,374,222)
during each period presented.
I) Comprehensive Income
In the first quarter of 1998, the Partnership adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
(SFAS 130). SFAS 130 requires the display and reporting of comprehensive
income, which includes all changes in partners' capital with the exception
of additional investments by partners or distributions to partners.
Comprehensive income for the Partnership includes net income and the
change in net unrealized holding gains (losses) on investments charged or
credited to Partners' Capital. Comprehensive income for the quarters
and six months ended June 30, 1998 and 1997 was as follows:
<TABLE>
<CAPTION>
For the For the For the Six For the Six
Quarter Ended Quarter Ended Months Ended Months Ended
June 30, 1998 June 30, 1997 June 30, 1998 June 30, 1997
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net income $ 573,249 $ 529,677 $ 1,140,550 $ 1,287,958
Change in net unrealized holding gains (losses) (6,745) 11,043 (2,707) (4,804)
--------------- --------------- --------------- ---------------
Comprehensive income $ 566,504 $ 540,720 $ 1,137,843 $ 1,283,154
=============== =============== =============== ===============
</TABLE>
<PAGE> - 5 -
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
3. Partnership Income, Expenses and Cash Distributions
Profits and losses from normal operations and cash available for distribution
will be allocated 99% to the investors and 1% to the General Partners.
Certain fees payable to the General Partners will not become due until
investors have received certain priority returns. Cash distributions included
in the consolidated financial statements represent the actual cash
distributions made during each period and the cash distributions accrued at
the end of each period.
The General Partners will also receive 1% of the net proceeds from any sale
of Partnership assets. The General Partners will receive a termination fee
equal to 3% of all sales proceeds less actual costs incurred in connection
with all sales transactions, payable only after the investors have received a
return of their capital contributions and a 13% annual return on a cumulative
basis. The General Partners will also receive a fee equal to 9.1% of all
cash available for distribution and sales proceeds (after deducting from cash
available or sales proceeds any termination fee paid therefrom) after
investors have received a return of their capital contributions and a 13%
annual return on a cumulative basis.
4. Transactions with Related Parties
The General Partners, certain of their affiliates and the Operating
Partnerships' general partners have received or may receive fees,
compensation, income, distributions and payments from the Partnership in
connection with the offering and the investment, management and sale of the
Partnership's assets (other than disclosed elsewhere) as follows.
The Operating Partnerships' general partners provide various on-site property
development and management services. There were no property development and
management fees incurred for the six months ended June 30, 1998. Unpaid fees,
which are non-interest bearing, are included in amounts due to general
partners and their affiliates on the accompanying consolidated balance sheets
and will be paid in accordance with the terms of the respective Operating
Partnership's limited partnership agreement.
The General Partners are entitled to receive an asset management and
partnership administration fee equal to 0.5% of invested assets per annum,
payable only during such years that an 8% return has been paid to investors on
a noncumulative basis. Any unpaid amounts will accrue and be payable only
after a 13% annual return to investors has been paid on a cumulative basis and
the investors have received the return of their capital contributions. For
the quarter and six months ended June 30, 1998, distributions to investors
represented less than an 8% return; accordingly, no fees were paid or accrued
during this period.
Amounts due to general partners and their affiliates at June 30, 1998, is
comprised of the following:
<TABLE>
<S> <C>
Unpaid property development and management fees $ 450,173
Operating deficit loans 3,511,553
---------------
$ 3,961,726
===============
</TABLE>
<PAGE> - 6 -
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
Substantially all of the Partnership's general and administrative expenses and
certain costs capitalized by the Partnership are paid by a General Partner or
an affiliate and reimbursed by the Partnership. The amount of such expenses
reimbursed to the General Partner for 1998 was $701,787 ($338,360 for the
quarter ended June 30, 1998). Reimbursed expenses are presented on a cash
basis and do not reflect accruals made at quarter end.
An affiliate of the General Partners has been retained to provide property
management services for Waterman's Crossing, Misty Springs Apartments, Fox
Hollow Apartments and The Ponds at Georgetown. The fees for services provided
in 1998, amounted to $97,062 ($48,446 for the quarter ended June 30, 1998),
and represented the lower of costs incurred in providing management of the
property or customary fees for such services determined on a competitive basis.
5. Partnership Reserve Account
The Partnership maintains a reserve account which consisted of the following
at June 30, 1998:
<TABLE>
<S> <C>
Cash and temporary cash investments $ 9,717,286
GNMA Certificates 967,089
---------------
$ 10,684,375
===============
</TABLE>
The reserve account was established to maintain working capital for the
Partnership and is available for distribution to BAC Holders and for any
contingencies related to Permanent Investments and the operation of the
Partnership. The GNMA Certificates mature between 2007 and 2009. At
June 30, 1998, the total amortized cost, gross unrealized holding gains and
aggregate fair value of available-for-sale securities were $926,180, $40,909
and $967,089, respectively.
6. Parent Company Only Financial Information
Generally accepted accounting principles require that the Partnership's
financial statements consolidate the Operating Partnerships since the
Partnership holds a majority ownership interest and, through CS Properties I,
Inc. can influence the decisions of the general partners in certain
circumstances. In the consolidated financial statements, the Partnership's
investment in FHA Loans and GNMA Certificates is eliminated against the
related mortgage payable recorded by the Operating Partnership. If a mortgage
loan goes into default and is foreclosed upon by FHA or GNMA, the respective
agency may, at their discretion, repay the FHA Loan or the GNMA Certificate.
If this occurs, the Partnership's investment in the Operating Partnership
would be eliminated, resulting in the recognition of a gain on the
Partnership's financial statements. This arises because consolidation
accounting does not allow the Partnership to stop recording losses from the
Operating Partnerships when the net investment is reduced to zero.
The parent company only financial information below represents the condensed
financial information of the Partnership using the equity method of accounting
for the investment in Operating Partnerships, rather than the consolidation of
those partnerships. Under the equity method of accounting, the Partnership's
capital contributions are adjusted to reflect its share of operating
partnership profits or losses and distributions. The investment in Operating
Partnerships represents the Partnership's limited partnership interest in the
accumulated deficits of those Operating Partnerships. The parent company only
information is provided to more clearly present the Partnership's investment
in the Operating Partnerships. Since the Partnership is not a general
partner, it is not obligated to fund the negative balances. If the
investments in all Operating Partnerships were eliminated at June 30, 1998,
Partnership capital would increase by $14,033,182 ($4.12 per BAC).
The FHA Loans and the GNMA Certificates are collateralized by first mortgage
loans on the properties owned by the Operating Partnerships and are guaranteed
or insured as to principal and interest by FHA or GNMA. The FHA insured
mortgage loans are subject to a 1% assignment fee. The obligations of FHA and
GNMA are backed by the full faith and credit of the United States government.
<PAGE> - 7 -
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
Parent Company Only
Condensed Balance Sheets
<TABLE>
<CAPTION>
June 30, 1998 Dec. 31, 1997
--------------- ---------------
<S> <C> <C>
Assets
Cash and temporary cash investments $ 10,053,718 $ 10,410,564
Investment in FHA Loans 12,471,160 12,511,046
Investment in GNMA Certificates 23,407,224 23,588,139
Investment in Operating Partnerships (14,033,182) (13,686,936)
Interest receivable 316,463 321,485
Other assets 479,660 134,574
--------------- ---------------
$ 32,695,043 $ 33,278,872
=============== ===============
Liabilities and Partners' Capital
Liabilities
Accounts payable $ 203,664 $ 204,142
Distributions payable 860,587 860,587
--------------- ---------------
1,064,251 1,064,729
Partners' Capital 31,630,792 32,214,143
--------------- ---------------
$ 32,695,043 $ 33,278,872
=============== ===============
</TABLE>
Parent Company Only
Condensed Statements of Income
<TABLE>
<CAPTION>
For the Six For the Six
Months Ended Months Ended
June 30, 1998 June 30, 1997
--------------- ---------------
<S> <C> <C>
Income
Mortgage and mortgage-backed securities income $ 1,599,661 $ 1,573,318
Interest on temporary cash investments 274,605 270,635
Interest on mortgage-backed securities 38,449 47,355
Equity in losses of Operating Partnerships (356,246) (364,656)
Other income 3,450 1,050
--------------- ---------------
1,559,919 1,527,702
Expenses
Operating and administrative 419,369 239,744
--------------- ---------------
Net income $ 1,140,550 $ 1,287,958
=============== ===============
</TABLE>
<PAGE> - 8 -
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
Parent Company Only
Condensed Statements of Cash Flows
<TABLE>
<CAPTION>
For the Six For the Six
Months Ended Months Ended
June 30, 1998 June 30, 1997
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities
Net income $ 1,140,550 $ 1,287,958
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in losses of Operating Partnerships 356,246 364,656
Amortization 33,744 33,744
Amortization of discount on mortgage-backed securities (1,313) (1,134)
Other non-cash adjustments (374,286) (44,140)
--------------- ---------------
Net cash provided by operating activities 1,154,941 1,641,084
--------------- ---------------
Cash flows from investing activities
FHA Loan and GNMA Certificate principal payments 219,407 194,311
Investment in Operating Partnerships (10,000) (78,550)
--------------- ---------------
Net cash provided by investing activities 209,407 115,761
--------------- ---------------
Cash flow used in financing activity
Distributions (1,721,194) (1,721,194)
--------------- ---------------
Net increase (decrease) in cash and temporary cash investments (356,846) 35,651
Cash and temporary cash investments at beginning of period 10,410,564 10,272,497
--------------- ---------------
Cash and temporary cash investments at end of period $ 10,053,718 $ 10,308,148
=============== ===============
</TABLE>
7. Mortgage Loan Payable
The mortgage collateralized solely by Fox Hollow Apartments provides for
interest at 8.86%. Installments of principal and interest in the amount of
$49,947 are due on the first day of each month with the balance of principal
and interest due and payable no later than October 1, 2028. The mortgage is
an obligation of the Operating Partnership which owns the property.
8. Proposed Merger
On May 7, 1998, a Registration Statement on Form S-4 was filed by America
First Real Estate Investment Company, Inc. (the Company) with the Securities
and Exchange Commission which includes a prospectus/consent solicitation
statement of the Partnership and Capital Source II L.P.-A, a sister
partnership with assets and investment objectives similar to the Partnership.
Upon approval of the proposed merger by investors in both partnerships, the
partnerships and their respective general partners will be combined into the
Company which will be engaged in the business of making real estate and
related investments. At their election and subject to certain limitations,
investors in each partnership will receive, in exchange for their partnership
units, shares of common stock in the Company (the Common Stock) or variable
rate junior notes (the Notes) of the Company. The Company intends to list
shares of Common Stock issued pursuant to the proposed merger on a national
securities exchange. The limited partners of the Partnership will receive a
prospectus/consent solicitation statement in the future, at which time they
will have the opportunity to vote on the proposed merger.
<PAGE> - 9 -
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Liquidity and Capital Resources
The Partnership originally acquired: (i) five mortgage-backed securities
guaranteed as to principal and interest by the Government National Mortgage
Association (GNMA) collateralized by first mortgage loans on multifamily
housing properties located in five states; (ii) three first mortgage loans
insured as to principal and interest by the Federal Housing Administration
(FHA) on multifamily housing properties located in two states; and (iii)
Partnership Equity Investments in eight limited partnerships which own the
multifamily properties financed by the GNMA Certificates and FHA Loans. The
Partnership subsequently received FHA Debentures in payment of the FHA Loan on
Fox Hollow Apartments which were paid in full in 1993. In 1994, foreclosure
proceedings were initiated on Falcon Point Apartments and, accordingly, the
Partnership no longer holds a Partnership Equity Investment in this property.
In addition, during 1995, the GNMA Certificate related to Falcon Point
Apartments was paid-in-full to the Partnership. Collectively, the remaining
GNMA Certificates, FHA Loans and Partnership Equity Investments are referred
to as the "Permanent Investments". The Partnership has also invested amounts
held in its reserve account in certain GNMA securities backed by pools of
single-family mortgages (Reserve Investments). The obligations of GNMA and
FHA are backed by the full faith and credit of the United States government.
The FHA Loans, GNMA Certificates and Partnership Equity Investments in
Operating Partnerships represent the Partnership's principal assets as shown
in the Parent Company Only Financial Information in Note 6 to the financial
statements. The parent company information is presented using the equity
method of accounting for the investment in Operating Partnerships. Generally
accepted accounting principles, however, require that the Partnership's
financial statements consolidate the Operating Partnerships, since the
Partnership holds a majority ownership in each Operating Partnership and can
influence decisions of the general partners in certain circumstances.
The following FHA Loans and GNMA Certificates were owned by the Partnership at
June 30, 1998.
<TABLE>
<CAPTION>
Guaranteed Interest Maturity Carrying
Property Name or Insured By Rate Date Value
- ---------------------------------------- --------------- ---------- --------------- ---------------
<S> <C> <C> <C> <C>
Bluff Ridge Apartments FHA 8.72% 11-15-2028 $ 3,498,880
Highland Park Apartments FHA 8.75% 11-01-2028 8,972,280
Misty Springs Apartments GNMA 8.75% 06-15-2029 4,259,606
The Ponds at Georgetown GNMA 9.00% 12-15-2029 2,228,101
Waterman's Crossing GNMA 10.00% 09-15-2028 10,901,262
Water's Edge Apartments GNMA 8.75% 12-15-2028 5,051,166
Pools of single-family mortgages GNMA 7.58%(1) 2008 to 2009 476,964
Pools of single-family mortgages GNMA 7.58%(1) 2007 to 2008 490,125
---------------
$ 35,878,384
===============
</TABLE>
(1) Represents yield to the Partnership.
<PAGE> - 10 -
Distributions
Cash distributions paid or accrued per BAC were as follows:
<TABLE>
<CAPTION>
For the Six For the Six
Months Ended Months Ended
June 30, 1998 June 30, 1997
--------------- ---------------
<S> <C> <C>
Regular quarterly distributions
Income $ .3346 $ .3779
Return of capital .1704 .1271
--------------- ---------------
.5050 .5050
=============== ===============
Distributions
Paid out of cash flow $ .5050 $ .5050
=============== ===============
</TABLE>
Regular quarterly distributions to BAC Holders consist primarily of interest
received on FHA Loans and GNMA Certificates. Additional cash for
distributions is received from other investments. The Partnership may draw on
reserves to pay operating expenses or to supplement cash distributions to
investors. The Partnership is permitted to replenish reserves with cash flows
in excess of distributions paid. For the six months ended June 30, 1998,
$28,753 ($41,349 for the quarter ended June 30, 1998) of undistributed cash
flow was placed in reserves. The total amount held in reserves at
June 30, 1998, was $10,684,375 of which $967,089 was invested in GNMA
Certificates.
The Partnership believes that cash provided by operating activities and, if
necessary, withdrawals from the Partnership's reserves will be adequate to
meet its short-term and long-term liquidity requirements, including the
payments of distributions to BAC Holders. Under the terms of its Partnership
Agreement, the Partnership has the authority to enter into short-term and
long-term debt financing arrangements; however, the Partnership currently does
not anticipate entering into such arrangements. The Partnership is not
authorized to issue additional BACs to meet short-term and long-term liquidity
requirements.
Asset Quality
The FHA Loans and GNMA Certificates owned by the Partnership are guaranteed as
to principal and interest by FHA and GNMA, respectively. The obligations of
FHA and GNMA are backed by the full faith and credit of the United States
government. The Partnership Equity Investments, however, are not insured or
guaranteed. The value of these investments is a function of the value of the
real estate owned by the Operating Partnerships.
In order to cure the ongoing mortgage default and tax delinquency at The Ponds
of Georgetown, a preliminary agreement has been reached between all parties to
the transaction. The general partners of the Operating Partnership which owns
The Ponds at Georgetown have agreed to withdraw from the partnership; CS
Properties I, Inc., which is owned by affiliates of the General Partner of the
Partnership and currently serves as a special limited partner for such
Operating Partnership, would become a substitute general partner along with CS
Properties II, Inc. which currently serves as the special limited partner
representing the partnership interests of Capital Source II, the owner of a
portion of the limited partnership interests in the Operating Partnership. It
is anticipated that the mortgage loan will be rewritten at its original
principal amount at a lower interest rate with anticipation that cash flow
from the property will be sufficient to cover all of the property's cash
needs, including the mortgage and taxes. Capital Source I, along with Capital
Source II, will be obligated to fund a portion of the delinquent taxes and
other outstanding amounts in conjunction with this agreement.
The overall status of the Partnership's other investments has remained
relatively constant since March 31, 1998.
<PAGE> - 11 -
The following table shows the occupancy levels of the properties financed by
the Partnership at June 30, 1998:
<TABLE>
<CAPTION>
Number Percentage
Number of Units of Units
Property Name Location of Units Occupied Occupied
- ------------------------------- -------------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Bluff Ridge Apartments Jacksonville, NC 108 104 96%
Fox Hollow Apartments High Point, NC 184 164 89%
Highland Park Apartments Columbus, OH 252 242 96%
Misty Springs Apartments Daytona Beach, FL 128 128 100%
The Ponds at Georgetown Ann Arbor, MI 134 131 98%
Waterman's Crossing Newport News, VA 260 260 100%
Water's Edge Apartments Lake Villa, IL 108 106 98%
------------- ------------ ------------
1,174 1,135 97%
============= ============ ============
</TABLE>
Results of Operations
The tables below compare the results of operations for each period shown.
<TABLE>
<CAPTION>
For the For the Increase
Quarter Ended Quarter Ended (Decrease)
June 30, 1998 June 30, 1997 From 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
Rental income $ 1,882,620 $ 1,874,301 $ 8,319
Mortgage-backed securities income 18,554 23,110 (4,556)
Interest income on temporary cash investments 139,402 141,384 (1,982)
Other income 99,083 63,082 36,001
--------------- --------------- ---------------
2,139,659 2,101,877 37,782
--------------- --------------- ---------------
Real estate operating expenses 978,062 1,065,971 (87,909)
Depreciation 224,688 224,393 295
Interest expense 148,844 149,841 (997)
Investor servicing 148,042 86,992 61,050
Professional fees 11,895 14,750 (2,855)
Other expenses 19,756 707 19,049
Amortization 35,371 34,199 1,172
--------------- --------------- ---------------
1,566,658 1,576,853 (10,195)
--------------- --------------- ---------------
Minority interest in losses of Operating Partnerships 248 4,653 (4,405)
--------------- --------------- ---------------
Net income $ 573,249 $ 529,677 $ 43,572
=============== =============== ===============
</TABLE>
<PAGE> - 12 -
<TABLE>
<CAPTION>
For the Six For the Six Increase
Months Ended Months Ended (Decrease)
June 30, 1998 June 30, 1997 From 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
Rental income $ 3,777,402 $ 3,701,485 $ 75,917
Mortgage-backed securities income 38,449 47,355 (8,906)
Interest income on temporary cash investments 280,690 284,747 (4,057)
Other income 176,962 153,106 23,856
--------------- --------------- ---------------
4,273,503 4,186,693 86,810
--------------- --------------- ---------------
Real estate operating expenses 1,928,918 1,885,371 43,547
Depreciation 449,374 448,785 589
Interest expense 298,685 299,682 (997)
Investor servicing 274,604 173,129 101,475
Professional fees 24,670 30,600 (5,930)
Other expenses 86,352 2,272 84,080
Amortization 70,740 68,398 2,342
--------------- --------------- ---------------
3,133,343 2,908,237 225,106
--------------- --------------- ---------------
Minority interest in losses of Operating Partnerships 390 9,502 (9,112)
--------------- --------------- ---------------
Net income $ 1,140,550 $ 1,287,958 $ (147,408)
=============== =============== ===============
</TABLE>
Rental income is recognized net of any vacancy losses and rental concessions
offered. Rental income, net of real estate operating expenses, depreciation,
and amortization, increased $94,761 and $29,439 for the quarter and six months
ended June 30, 1998, respectively, compared to the same periods in 1997.
Rental income increased approximately 2% for the six months ended June 30,
1998, compared to the same period in 1997. This increase was partially offset
by a 2% increase in real estate operating expenses and slight increases in
depreciation and amortization. Contributing to the increase for the quarter
was a slight increase in rental income and a decrease in real estate operating
expenses primarily due to a decrease in repairs and maintenance expenses and
property improvements which were partially offset by slight increases in
depreciation and amortization.
Mortgage-backed securities income decreased for the quarter and six months
ended June 30, 1998, compared to the same periods in 1997 due to the continued
amortization of the principal balance of the mortgage-backed securities.
Interest income on temporary cash investments decreased for the quarter and
six months ended June 30, 1998, compared to the same periods in 1997 due to a
decrease in the Partnership's cash reserve as cash was withdrawn from reserves
during the first quarter of 1998 to supplement distributions to BAC Holders.
Other income consists primarily of corporate unit rentals, garage rentals,
washer/dryer, and vending income generated by the Partnership's properties.
Income from such sources increased for the quarter and six months ended
June 30, 1998, respectively, compared to the same periods in 1997. Other
income increased primarily due to an increase in corporate unit rentals.
Investor servicing costs increased for the quarter and six months ended June
30, 1998, compared to the same periods in 1997, due to an increase in salaries
and related expenses, which were partially offset by a decrease in other
investor servicing expenses. Salaries and related expenses increased as
additional management time was incurred in conjunction with the proposed
merger described in Note 8 to the consolidated financial statements.
Professional fees decreased for the quarter and six months ended June 30,
1998, compared to the same periods in 1997, primarily due to a decrease in
legal fees. Other expenses increased for the quarter and six months ended
June 30, 1998, compared to the same periods in 1997, primarily due to an
increase in consulting fees and travel expenses.
<PAGE> - 13 -
This report contains forward looking statements that reflect management's
current beliefs and estimates of future economic circumstances, industry
conditions, the Partnership's performance and financial results. All
statements, trend analysis and other information concerning possible or
assumed future results of operations of the Partnership and the real estate
investments it has made (including, but not limited to, the information
contained in "Management's Discussion and Analysis of Financial Condition and
Results of Operations"), constitute forward-looking statements. BAC Holders
and others should understand that these forward looking statements are subject
to numerous risks and uncertainties and a number of factors could affect the
future results of the Partnership and could cause those results to differ
materially from those expressed in the forward looking statements contained
herein.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The requirements of Item 3 of Form 10-Q are not applicable to the Partnership
prior to its Annual Report on Form 10-K for the year ending December 31, 1998.
<PAGE> - 14 -
PART II. OTHER INFORMATION
Item 5. Other Information
On May 7, 1998, a Registration Statement on Form S-4 was filed
by America First Real Estate Investment Company, Inc. (the
Company) with the Securities and Exchange Commission which
includes a consent solicitation statement of the Partnership
and Capital Source II L.P.-A, a sister partnership with assets
and investment objectives similar to the Partnership. Upon
approval of the proposed plan by investors in both
partnerships, the partnerships will be combined into the
Company which will be engaged in the business of making real
estate and related investments. At their election and subject
to certain limitations, investors in each partnership will
receive, in exchange for their partnership units, shares of
common stock in the Company (the Common Stock) or variable rate
notes (the Notes) of the Company. The Company intends to list
shares of Common Stock issued pursuant to the planned merger on
a national securities exchange.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
4(a) Agreement of Limited Partnership of Capital Source
L.P. (incorporated herein by reference from Exhibit A of
the Prospectus contained in the Registrant's
Post-Effective Amendment No. 3 dated May 15, 1986 to the
Registration Statement on Form S-11 (Commission File No.
0-16497)).
4(b) Beneficial Assignment Certificate (incorporated by
reference to page 47 of Form 10-K for the fiscal year
ended December 31, 1989 filed with the Securities and
Exchange Commission by the Registrant (Commission File No.
0-16497)).
(b) Form 8-K
The registrant did not file a report on Form 8-K during the
quarter for which this report is filed.
<PAGE> - 15 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
CAPITAL SOURCE L.P.
By America First Capital
Source I L.L.C., General
Partner of the Registrant
By /s/ Michael Thesing
Michael Thesing,
Vice President and
Principal Financial Officer
Dated: August 13, 1998
<PAGE> - 16 -
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 10,308,148
<SECURITIES> 1,220,024
<RECEIVABLES> 221,361
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 10,529,509
<PP&E> 40,607,477
<DEPRECIATION> (10,374,421)
<TOTAL-ASSETS> 45,580,973
<CURRENT-LIABILITIES> 2,156,255
<BONDS> 0
<COMMON> 0
0
0
<OTHER-SE> 32,813,838
<TOTAL-LIABILITY-AND-EQUITY> 45,580,973
<SALES> 0
<TOTAL-REVENUES> 4,186,693
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2,908,237
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,287,958
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,287,958
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,287,958
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
