FORM 10-Q/A
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.
BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
June 30, 1998 Dec. 31, 1997
-------------- --------------
<S> <C> <C>
Assets
Cash and temporary cash investments, at cost which
approximates market value $ 10,053,718 $ 10,410,564
Investment in FHA Loans (Note 5) 12,471,160 12,511,046
Investment in GNMA Certificates (Note 5) 23,407,224 23,588,139
Investment in Operating Partnerships (Note 6) - -
Interest receivable 316,463 321,485
Other assets 479,660 134,574
-------------- --------------
$ 46,728,225 $ 46,965,808
============== ==============
Liabilities and Partners' Capital (Deficit)
Liabilities
Accounts payable (Note 7) $ 203,664 $ 204,142
Distribution payable (Note 4) 860,587 860,587
-------------- --------------
1,064,251 1,064,729
-------------- --------------
Partners' Capital (Deficit)
General Partner (159,018) (156,647)
Beneficial Assignment Certificate Holders
($13.58 per BAC in 1998 and $13.65 in 1997) 45,822,992 46,057,726
-------------- --------------
45,663,974 45,901,079
-------------- --------------
$ 46,728,225 $ 46,965,808
============== ==============
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE> - 1 -
CAPITAL SOURCE L.P.
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
Mortgage-backed securities income $ 817,818 $ 826,753 $ 1,638,110 $ 1,655,673
Interest income on temporary cash investments 136,428 137,159 274,605 270,635
Equity in losses of Operating Partnerships - (78,550) (10,000) (113,550)
Other income 2,300 350 3,450 1,050
--------------- --------------- --------------- ---------------
956,546 885,712 1,906,165 1,813,808
Expenses
Operating and administrative expenses (Note 7) 196,565 119,321 419,369 239,744
--------------- --------------- --------------- ---------------
Net income $ 759,981 $ 766,391 $ 1,486,796 $ 1,574,064
=============== =============== =============== ===============
Net income allocated to:
General Partner $ 7,600 $ 7,664 $ 14,868 $ 15,741
Limited Partners 752,381 758,727 1,471,928 1,558,323
--------------- --------------- --------------- ---------------
$ 759,981 $ 766,391 $ 1,486,796 $ 1,574,064
=============== =============== =============== ===============
Net income, basic and diluted, per BAC $ .22 $ .22 $ .44 $ .46
=============== =============== =============== ===============
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE> - 2 -
CAPITAL SOURCE L.P.
STATEMENT OF PARTNERS CAPITAL (DEFICIT)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
General BAC
Partner Holders Total
-------------- ---------------- ---------------
<S> <C> <C> <C>
Partners' Capital(Deficit) (excluding net unrealized holding gains)
Balance at December 31, 1997, as previously reported $ (293,953) $ 32,464,480 $ 32,170,527
Effect of restatement (Note 2.H.) 136,870 13,550,066 13,686,936
-------------- ---------------- ---------------
Balance at December 31, 1997, as restated (157,083) 46,014,546 45,857,463
Net income 14,868 1,471,928 1,486,796
Cash distributions paid or accrued (Note 4) (17,212) (1,703,982) (1,721,194)
-------------- ---------------- ---------------
(159,427) 45,782,492 45,623,065
-------------- ---------------- ---------------
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 $ (159,018) $ 45,822,992 $ 45,663,974
============== ================ ===============
</TABLE>
CAPITAL SOURCE L.P.
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 $ 1,486,796 $ 1,574,064
Adjustments to reconcile net income to net cash
from operating activities
Equity in losses of Operating Partnerships 10,000 113,550
Amortization of discount on mortgage-backed securities (1,313) (1,134)
Decrease in interest receivable 5,022 1,710
Increase in other assets (345,086) 28,995
Decrease in accounts payable (478) (41,101)
--------------- ---------------
Net cash provided by operating activities 1,154,941 1,676,084
--------------- ---------------
Cash flows from investing activities
FHA Loan and GNMA principal payments received 219,407 194,311
Investment in Operating Partnerships (10,000) (113,550)
--------------- ---------------
Net cash provided by investing activities 209,407 80,761
--------------- ---------------
Cash flow used in financing activity
Distributions paid (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
=============== ===============
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE> - 3 -
CAPITAL SOURCE L.P.
NOTES TO 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 was formed to invest principally in federally-insured
mortgages on multifamily housing properties and limited partnership interests
in the Operating Partnerships which construct and operate these properties.
Each federally insured loan is guaranteed in amounts equal to the face amount
of the mortgage, by the Federal Housing Administration (FHA) or the Government
National Mortgage Association (GNMA). Hereinafter, the Partnership's
investments in such mortgages are referred to as investments in
mortgage-backed securities. The 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 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 financial statements of the Partnership are prepared without audit on
the accrual basis of accounting in accordance with generally accepted
accounting principles. The financial statements should be read in
conjunction with the financial statements and notes thereto included in
the Partnership's Annual Report on Form 10-K/A 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.
B) Investment in Mortgage-Backed Securities
Investment securities are classified as held-to-maturity,
available-for-sale, or trading. Investments classified as
held-to-maturity are carried at amortized cost. Investments classified as
available-for-sale are reported at fair value, as determined by reference
to published sources. Any unrealized gains or losses are 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 trading.
<PAGE> - 4 -
CAPITAL SOURCE L.P.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
C) Investment in Operating Partnerships
The investment in Operating Partnerships consists of interests in limited
partnerships which own properties underlying the mortgage-backed
securities and are accounted for using the equity method. The investments
by the Partnership in the Operating Partnerships were recorded at the cost
to acquire such interests. Subsequently losses were recorded by the
Partnership as they were realized by the Operating Partnerships. The
Partnership suspended recognizing losses in the Operating Partnerships
when its entire initial investment had been consumed by such losses.
Subsequently, losses have been recognized only to the extent of additional
contributions net of distributions received, to the Operating Partnerships
by the Partnership. The Operating Partnerships 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. With regard to the
Operating Partnerships, the Partnership is not the general partner and it
has no legal obligation to provide additional cash support, nor has it
indicated any commitment to provide this support; accordingly it has not
reduced its investment in these Operating Partnerships below zero.
D) Income Taxes
No provision has been made for income taxes since Beneficial Assignment
Certificate (BAC) Holders are required to report their share of the
Partnership's income for federal and state income tax purposes.
E) Temporary Cash Investments
Temporary cash investments are invested in short-term debt securities
purchased with an original maturity of three months or less.
F) Net Income Per BAC
Net income per BAC has been calculated based on the number of BACs
outstanding (3,374,222) for all periods presented.
G) 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 losses on investments charged or credited
to Partners' Capital. Comprehensive income for the quarter and six months
ended June 30, 1998, compared to the same periods in 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 $ 759,981 $ 766,391 $ 1,486,796 $ 1,574,064
Change in net unrealized holding gains (losses) (6,745) 11,043 (2,707) (4,804)
--------------- --------------- --------------- ---------------
Comprehensive income $ 753,236 $ 777,434 $ 1,484,089 $ 1,569,260
=============== =============== =============== ===============
</TABLE>
H) Restatement
The Partnership holds a majority ownership interest and through CS
Properties I, Inc. can influence the decisions of the general
partners of the Operating Partnerships in certain circumstances.
Accordingly, the Partnership had consolidated the Operating Partnerships
since inception. In 1998 it was determined that this influence did not
constitute control of the Operating Partnerships. Therefore, the
accompanying financial statements have been restated to deconsolidate the
Operating Partnerships under the equity method of accounting rather than
consolidation.
<PAGE> - 5 -
CAPITAL SOURCE L.P.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
Under the equity method of accounting, the Partnership's investments are
adjusted to reflect its share of Operating Partnership profits or losses
and distributions. As required by consolidation accounting, the
Partnership had recorded losses from the Operating Partnerships
substantially in excess of its investments. As previously disclosed,
the Partnership is not the general partner, nor is it obliged to fund the
negative balances. Under equity accounting, the Partnership does not
reduce the carrying value of its investments below zero. As restated,
investments in the Operating Partnerships are reflected at zero and profits
and losses are recorded based on capital contributions made and
distributions received from the Operating Partnerships.
The restatement increased partners' capital at December 31, 1997 by
$13,686,936 which was the negative balance of the investment in Operating
Partnerships at that date. The restatement further increased net income for
the quarter and six months ended June 30, 1998 by $186,732 and $346,246,
respectively. Net income per BAC (basic and diluted) increased by $.06 and
$.11. The restatement further increased net income for the quarter and six
months ended June 30, 1997 by $236,714 and $286,106, respectively. Net
income per BAC (basic and diluted) increased by $.07 and $.08.
3. 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 the Partnership's investment in its mortgage backed
securities and the operation of the Partnership. See Note 5 regarding the
investment in mortgage backed securities.
4. Partnership Income, Expenses and Cash Distributions
Profits and losses from continuing operations and cash available for
distribution will be allocated 99% to the investors and 1% to the General
Partner. Certain fees payable to the General Partner will not become due
until investors have received certain priority returns. Cash distributions
included in the financial statements represent the actual cash distributions
made during each period and the change in cash distributions accrued at the
end of each period.
The General Partner will also receive 1% of the net proceeds from any sale
of Partnership assets. The General Partner 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 Partner 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.
<PAGE> - 6 -
CAPITAL SOURCE L.P.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
5. Investment in Mortgage-Backed Securities
The mortgage-backed securities held by the Partnership represent Government
National Mortgage Association (GNMA) Certificates and Federal Housing
Administration (FHA) Loans. The GNMA Certificates are backed by
first mortgage loans on multifamily housing properties and pools of
single-family properties. The GNMA Certificates are debt securities issued
by a private mortgage lender and are guaranteed by GNMA as to the full and
timely payment of principal and interest on the underlying loans. The FHA
Loans are guaranteed as to the full and timely payment of principal and
interest on the underlying loans.
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. At June 30, 1998, the total amortized cost, gross
unrealized holding gains and aggregate fair value of held-to-maturity
securities were $34,911,295, $539,948 and $35,451,243, respectively.
Descriptions of the Partnership's mortgage-backed securities at June 30,
1998, are as follows:
<TABLE>
<CAPTION>
Number Interest Maturity Carrying
Type of Security and Name Location of Units Rate Date Amount
---------------------------------- -------------------- -------- -------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
Held-to-Maturity
GNMA Certificates:
Misty Springs Apartments Daytona Beach, FL 128 8.75% 06-15-2029 $ 4,259,606
The Ponds at Georgetown Ann Arbor, MI 134 9.00% 12-15-2029 2,228,101
Waterman's Crossing Newport News, VA 260 10.00% 09-15-2028 10,901,262
Water's Edge Apartments Lake Villa, IL 108 8.75% 12-15-2028 5,051,166
---------------
22,440,135
FHA Loans:
Bluff Ridge Apartments Jacksonville, NC 108 8.72% 11-15-2028 3,498,880
Highland Park Apartments Columbus, OH 252 8.75% 11-01-2028 8,972,280
---------------
34,911,295
---------------
Available-for-sale
GNMA Certificates:
Pools of single-family mortgages 7.58%(1) 2008 to 2009 476,964(2)
Pools of single-family mortgages 7.58%(1) 2007 to 2008 490,125(2)
---------------
967,089
---------------
Balance at June 30, 1998 $ 35,878,384
===============
</TABLE>
(1) Represents yield to the Partnership.
(2) Reserve account asset - see Note 3.
Reconciliation of the carrying amount of the mortgage-backed securities is as
follows:
<TABLE>
<S> <C>
Balance at December 31, 1997 $ 36,099,185
Addition
Amortization of discount on mortgage-backed securities 1,313
Deductions
FHA Loan and GNMA principal payments received (219,407)
Change in net unrealized holding gains (2,707)
---------------
Balance at June 30, 1998 $ 35,878,384
===============
</TABLE>
<PAGE> - 7 -
CAPITAL SOURCE L.P.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
6. Investment in Operating Partnerships
The Partnership's Operating Partnerships consist of interests in limited
partnerships which own multifamily properties financed by the GNMA
Certificates and FHA Loans held by the Partnership. The limited partnership
agreements originally provided for the payment of a base return on the equity
provided to the limited partnerships and for the payment of additional amounts
out of a portion of the net cash flow or net sale or refinancing proceeds of
the properties subject to various priority payments.
Descriptions of the Operating Partnerships at June 30, 1998, are as follows:
<TABLE>
<CAPTION>
Carrying
Name Location Partnership Name Amount
- ------------------------ --------------------- ----------------------------------------- ------------
<S> <C> <C> <C>
Misty Springs Apartments Daytona Beach, FL Cypress Landings II, Ltd. $ -
The Ponds at Georgetown Ann Arbor, MI Ponds at Georgetown Limited Partnership -
Waterman's Crossing Newport News, VA Oyster Cove Limited Partnership -
Water's Edge Apartments Lake Villa, IL Water's Edge Limited Partnership -
Bluff Ridge Apartments Jacksonville, NC Bluff Ridge Associates Limited Partnership -
Highland Park Apartments Columbus, OH Interstate Limited Partnership -
------------
Balance at June 30, 1998 $ -
============
</TABLE>
Reconciliation of the carrying amount of the Operating Partnerships is as
follows:
<TABLE>
<CAPTION>
For the
Six Months Ended
June 30, 1998
---------------
<S> <C>
Balance at beginning of year $ -
Addition
Investment in Operating Partnerships 10,000
Deduction
Equity in losses of Operating Partnerships 10,000
---------------
Balance at end of period $ -
===============
7. 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 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.
<PAGE> - 8 -
CAPITAL SOURCE L.P.
NOTES TO 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). These 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.
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.
Distributions
Cash distributions paid or accrued per BAC were as follows:
</TABLE>
<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 $ .4362 $ .4618
Return of capital .0688 .0432
--------------- ---------------
$ .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.
<PAGE> - 10 -
Year 2000
The Partnership does not own or operate its own computer system and owns no
business or other equipment. However, the operation of the Partnership's
business relies on the computer system and other equipment maintained by
America First Companies L.L.C., the parent company of its general partners
("America First"). In addition, the Partnership has business relationships
with a number of third parties whose ability to perform their obligations to
the Partnership depend on such systems and equipment. Some or all of these
systems and equipment may be affected by the inability of certain computer
programs and embedded circuitry to correctly recognize dates occurring after
December 31, 1999. America First has adopted a plan to deal with this
so-called "Year 2000 problem" with respect to its information technology
("IT") systems, non-IT systems and third party business relationships.
State of Readiness
The IT system maintained by America First consists primarily of personal
computers, most of which are connected by a local area network. All
accounting and other record keeping functions relating to the Partnership that
are conducted in house by America First are performed on this PC-LAN system.
America First does not own or operate any "mainframe" computer systems. The
PC-LAN system runs software programs that America First believes are
compatible with dates after December 31, 1999. America First has engaged a
third party computer consulting firm to review and test its PC-LAN system to
ensure that it will function correctly after that date and expects that this
process, along with any necessary remediation, will be completed by March 31,
1999. America First believes any Year 2000 problems relating to its IT
systems will resolved without significant operational difficulties. However,
there can be no assurance that testing will discover all potential Year 2000
problems or that it will not reveal unanticipated material problems with the
America First IT systems that will need to be resolved.
Non-IT systems include embedded circuitry such as microcontrollers found in
telephone equipment, security and alarm systems, copiers, fax machines, mail
room equipment, heating and air conditioning systems and other infrastructure
systems that are used by America First in connection with the operation of the
Partnership's business. America First is reviewing its non-IT systems along
with the providers that service and maintain these systems, with initial
emphasis being placed on those, such as telephone systems, which have been
identified as necessary to America First's ability to conduct the operation of
the Partnership's business activities. America First expects that any
necessary modification or replacement of such "mission critical" systems will
be accomplished by mid-1999.
The Partnership has no control over the remediation efforts of third parties
with which it has material business relationships and the failure of certain
of these third parties to successfully remediate their Year 2000 issues could
have a material adverse effect on the Partnership. Accordingly, America First
has undertaken the process of contacting each such third party to determine
the state of their readiness for Year 2000. Such parties include, but are not
limited to, the obligors on the Partnership's GNMA Certificates and FHA Loans,
the Partnership's transfer and paying agent and the financial institutions
with which the Partnership maintains accounts. America First has received
initial assurances from certain of these third parties that their ability to
perform their obligations to the Partnership are not expected to be materially
adversely affected by the Year 2000 problem. America First will continue to
request updated information from these material third parties in order to
access their Year 2000 readiness. If a material third party vendor is unable
to provide assurance to America First that it is, or will be, ready for Year
2000, America First intends to seek an alternative vendor to the extent
practical.
<PAGE> - 11 -
Costs
All of the IT systems and non-IT systems used to conduct the Partnership's
business operations are owned or leased by America First. Under the terms of
its partnership agreement, neither America First nor the Partnership's general
partners may be reimbursed by the Partnership for expenses associated with
their computer systems or other business equipment. Therefore, the costs
associated with the identification, remediation and testing of America First's
IT and non-IT systems will be paid by America First rather than the
Partnership. The Partnership will bear its proportionate share of the costs
associated with surveying the Year 2000 readiness of third parties. However,
the Partnership's share of the costs associated with these activities are
expected to be insignificant. Accordingly, the costs associated with
addressing the Partnership's Year 2000 issues are not expected to have a
material effect on the Partnership's results of operations, financial position
or cash flow.
Year 2000 Risks
The Partnership's general partners believe that the most reasonably likely
worst-case scenario will be that one or more of the third parties with which
it has a material business relationship will not have successfully dealt with
its Year 2000 issues and, as a result, is unable to provide services or
otherwise perform its obligations to the Partnership. For example, if an
obligor on the Partnership's GNMA Certificates or FHA Loans encounters a
serious and unexpected Year 2000 issue, it may be unable to make a timely
payment of principal and interest to the Partnership. This, in turn, could
cause a delay or temporary reduction in cash distributions to BAC holders. In
addition, if the Partnership's transfer and paying agent experiences Year
2000-related difficulties, it may cause delays in making distributions to BAC
holders or in the processing of transfers of BACs. It is also possible that
one or more of the IT and non-IT systems of America First will not function
correctly, and that such problems may make it difficult to conduct necessary
accounting and other record keeping functions for the Partnership. However,
based on currently available information, the general partners do not believe
that there will be any protracted systemic failures of the IT or non-IT
systems utilized by America First in connection with the operation of the
Partnership's business.
Contingency Plans
Because of the progress which America First has made toward achieving Year
2000 readiness, the Partnership has not made any specific contingency plans
with respect to the IT and non-IT systems of America First. In the event of a
Year 2000 problem with its IT system, America First may be required to
manually perform certain accounting and other record-keeping functions.
America First plans to terminate the Partnership's relationships with material
third party service providers that are not able to represent to America First
that they will be able to successfully resolve their material Year 2000 issues
in a timely manner. However, the Partnership will not be able to terminate
its relationships with certain third parties, such as the obligors on its GNMA
Certificates and FHA Loans, who may experience Year 2000 problems. The
Partnership has no specific contingency plans for dealing with Year 2000
problems experienced with these third parties.
All forecasts, estimates or other statements in this report relating to the
Year 2000 readiness of the Partnership and its affiliates are based on
information and assumptions about future events. Such "forward-looking
statements" are subject to various known and unknown risks and uncertainties
that may cause actual events to differ from such statements. Important
factors upon which the Partnership's Year 2000 forward-looking statements are
based include, but are not limited to, (a) the belief of America First that
the software used in IT systems is already able to correctly read and
interpret dates after December 31, 1999 and will require little or any
remediation; (b) the ability to identify, repair or replace mission critical
non-IT equipment in a timely manner, (c) third parties' remediation of their
internal systems to be Year 2000 ready and their willingness to test their
systems interfaces with those of America First, (d) no third party system
failures causing material disruption of telecommunications, data transmission,
payment networks, government services, utilities or other infrastructure, (e)
no unexpected failures by third parties with which the Partnership has a
material business relationship and (f) no material undiscovered flaws in
America First's Year 2000 testing process.
<PAGE> - 12 -
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 underlying the Operating Partnerships. The fair value of the
properties underlying the Operating Partnerships is based on management's best
estimate of the fair value of such properties; however, the ultimate realized
values may vary from these estimates.
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, have agreed to contribute additional capital for 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.
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%
============= ============ ============
<PAGE> - 13 -
Results of Operations
The tables below compare the results of operations for each period shown.
</TABLE>
<TABLE>
<CAPTION>
For the For the Increase
Quarter Ended Quarter Ended (Decrease)
June 30, 1998 June 30, 1997 From 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
Mortgage-backed securities income $ 817,818 $ 826,753 $ (8,935)
Interest income on temporary cash investments 136,428 137,159 (731)
Equity in losses of Operating Partnerships - (78,550) 78,550
Other income 2,300 350 1,950
--------------- --------------- ---------------
956,546 885,712 70,834
Operating and administrative expenses 196,565 119,321 77,244
--------------- --------------- ---------------
Net income $ 759,981 $ 766,391 $ (6,410)
=============== =============== ===============
</TABLE>
<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>
Mortgage-backed securities income $ 1,638,110 $ 1,655,673 $ (17,563)
Interest income on temporary cash investments 274,605 270,635 3,970
Equity in losses of Operating Partnerships (10,000) (113,550) 103,550
Other income 3,450 1,050 2,400
--------------- --------------- ---------------
1,906,165 1,813,808 92,357
Operating and administrative expenses 419,369 239,744 179,625
--------------- --------------- ---------------
Net income $ 1,486,796 $ 1,574,064 $ (87,268)
=============== =============== ===============
</TABLE>
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 balances of the Partnership's mortgage-backed
securities.
The recognition of equity in losses of Operating Partnerships have been
suspended, limited to the extent distributions are received and capital
investments are made. During the six months ended June 30, 1998, the
Partnership made additional investments in certain Operating Partnerships of
$10,000 (none for the quarter). During the six months ended June 30, 1997,
the Partnership made additional investments in certain Operating Partnerships
of $113,550 ($78,550 for the quarter). The Partnership recorded equity in
losses of Operating Partnerships for the respective periods to the extent of
the additional investments.
Operating and administrative expenses increased for the quarter and six months
ended June 30, 1998, compared to the same periods in 1997 primarily due to
increases in salaries and related expenses, consulting expenses and travel
expenses. Salaries and related expenses increased as additional management
time was incurred in conjunction with the proposed merger described in Note 8
to the financial statements.
<PAGE> - 14 -
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.
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 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 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: October 26, 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> 10,053,718
<SECURITIES> 35,878,384
<RECEIVABLES> 316,463
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 46,728,225
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 46,728,225
<CURRENT-LIABILITIES> 1,064,251
<BONDS> 0
<COMMON> 0
0
0
<OTHER-SE> 45,663,974
<TOTAL-LIABILITY-AND-EQUITY> 46,728,225
<SALES> 0
<TOTAL-REVENUES> 1,906,165
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 419,369
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,486,796
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,486,796
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
