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: 0-16862
CAPITAL SOURCE II L.P.-A
(Exact name of registrant as specified in its charter)
Delaware 38-2684691
(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 II L.P.-A
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
June 30, 1998 Dec. 31, 1997
-------------- --------------
<S> <C> <C>
Assets
Investment in real estate:
Land $ 2,800,750 $ 2,800,750
Buildings 23,055,361 23,055,361
Personal property 1,685,797 1,666,485
-------------- -------------
27,541,908 27,522,596
Less accumulated depreciation (6,662,128) (6,330,294)
-------------- -------------
Net investment in real estate 20,879,780 21,192,302
Cash and temporary cash investments, at cost
which approximates market value (Note 5) 654,703 1,240,992
Escrow deposits and property reserves 1,409,154 1,104,823
Investment in mortgage-backed securities (Note 5) 579,194 1,050,718
Interest and other receivables 10,792 19,443
Deferred mortgage issuance costs net of accumulated
amortization of $847,912 in 1998 and $792,341 in 1997 1,533,939 1,589,510
Other assets 206,965 241,498
-------------- --------------
$ 25,274,527 $ 26,439,286
============== ==============
Liabilities and Partners' Capital (Deficit)
Liabilities
Accounts payable and accrued expenses $ 1,305,847 $ 1,118,970
Distribution payable (Note 3) 546,968 546,968
Due to general partners and their affiliates (Note 4) 1,003,346 1,067,313
-------------- --------------
2,856,161 2,733,251
-------------- --------------
Minority interest 205,440 205,603
-------------- --------------
Partners' Capital (Deficit)
General Partners (344,328) (331,453)
Limited Partners ($5.62 per BAC in 1998 and $5.94 in 1997) 22,557,254 23,831,885
-------------- --------------
22,212,926 23,500,432
-------------- --------------
$ 25,274,527 $ 26,439,286
============== ==============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
<PAGE> -1-
CAPITAL SOURCE II L.P.-A
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 $ 1,286,571 $ 1,249,784 $ 2,546,469 $ 2,507,224
Interest income on temporary cash investments 10,291 26,758 26,991 56,729
Mortgage-backed securities income 14,492 20,785 33,373 42,269
Other income 41,738 51,018 81,992 95,539
Gain on sale of mortgage-backed securities (Note 5) 14,565 - 14,565 -
-------------- -------------- -------------- --------------
1,367,657 1,348,345 2,703,390 2,701,761
-------------- -------------- -------------- --------------
Expenses
Real estate operating expenses 655,490 628,200 1,284,192 1,157,158
Depreciation 165,919 165,983 331,834 331,965
Property development and management fees (Note 4) - - 701 -
General and administrative expenses (Note 4)
Investor servicing 135,515 77,034 255,135 155,394
Professional fees 75,200 10,550 271,762 22,200
Other expenses 6,150 3,905 50,362 8,431
Asset management and partnership
administration fees (Note 4) 41,500 41,500 83,000 83,000
Amortization 27,783 27,800 55,571 55,600
-------------- -------------- -------------- --------------
1,107,557 954,972 2,332,557 1,813,748
-------------- -------------- -------------- --------------
Minority interest in losses of
Operating Partnerships 73 181 163 328
-------------- -------------- -------------- --------------
Net income $ 260,173 $ 393,554 $ 370,996 $ 888,341
============== ============== ============== ==============
Net income allocated to:
General Partners $ 2,602 $ 3,935 $ 3,710 $ 8,883
Limited Partners 257,571 389,619 367,286 879,458
-------------- -------------- -------------- --------------
$ 260,173 $ 393,554 $ 370,996 $ 888,341
============== ============== ============== ==============
Net income, basic and diluted, per BAC $ .06 $ .10 $ .09 $ .22
============== ============== ============== ==============
</TABLE>
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 $ (331,875) $ 23,790,096 $ 23,458,221
Net income 3,710 367,286 370,996
Cash distributions paid or accrued (Note 3) (16,409) (1,624,496) (1,640,905)
-------------- -------------- --------------
(344,574) 22,532,886 22,188,312
-------------- -------------- --------------
Net unrealized holding gains
Balance at December 31, 1997 422 41,789 42,211
Net change (176) (17,421) (17,597)
-------------- -------------- --------------
246 24,368 24,614
-------------- -------------- --------------
Balance at June 30, 1998 $ (344,328) $ 22,557,254 $ 22,212,926
============== ============== ==============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
<PAGE> -2-
CAPITAL SOURCE II L.P.-A
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 $ 370,996 $ 888,341
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 387,405 387,565
Amortization of discount on mortgage-backed securities (1,037) (711)
Property development and management fees 701 -
Minority interest in losses of Operating Partnerships (163) (328)
Gain on sale of mortgage-backed securities (14,565) -
Decrease in interest and other receivables 8,651 2,995
Increase in escrow deposits and property reserves (304,331) (323,955)
Decrease in other assets 34,533 9,572
Increase in accounts payable and accrued expenses 186,877 7,917
Decrease in due to general partners and their affiliates (64,668) (75,034)
-------------- --------------
Net cash provided by operating activities 604,399 896,362
-------------- --------------
Cash flows from investing activities
Proceeds from sale of mortgage-backed securities 374,711 -
Principal payments on mortgage-backed securities 94,818 64,936
Acquisition of personal property (19,312) (20,891)
Acquisition of buildings and construction in progress - (200)
-------------- --------------
Net cash provided by investing activities 450,217 43,845
-------------- --------------
Cash flow used in financing activity
Distributions (1,640,905) (1,640,905)
-------------- --------------
Net decrease in cash and temporary cash investments (586,289) (700,698)
Cash and temporary cash investments at beginning of period 1,240,992 2,430,937
-------------- --------------
Cash and temporary cash investments at end of period $ 654,703 $ 1,730,239
============== ==============
Supplemental disclosure of non-cash investing activity:
Write-off of fully depreciated assets $ - $ 1,936
============== ==============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
<PAGE> -3-
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
1. Organization
Capital Source II L.P.-A (the Partnership) was formed on August 22, 1986,
under the Delaware Revised Uniform Limited Partnership Act. The General
Partners of the Partnership are Insured Mortgage Equities II L.P. and America
First Capital Source II, L.L.C. (the General Partners).
The Partnership provided virtually 100% of the debt and equity financing for
five 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 GNMA
on one of its GNMA Certificates and the related property has been deeded to
GNMA in lieu of foreclosure thus eliminating the Partnership's Equity
Investment. The four remaining Operating Partnerships are geographically
located as follows: (i) two in Michigan; and, (ii) one each in Florida and
North Carolina.
CS Properties II, 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.
The Partnership will terminate subsequent to the sale of all properties but in
no event will the Partnership continue beyond December 31, 2035.
2. Summary of Significant Accounting Policies
A)Financial Statement Presentation
The consolidated financial statements include the accounts of the
Partnership and four subsidiary Operating Partnerships. The Partnership is
a limited partner with an ownership interest in three of the subsidiary
Operating Partnerships of up to 99%. The Partnership's ownership interest
in The Ponds at Georgetown L.P. is 68.70%. The remaining limited partner
interest of 30.29% is owned by Capital Source L.P., 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.
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.
<PAGE> -4-
Capital Source II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
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 was calculated based on the number of BACs outstanding
(4,011,101) 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 $ 260,173 $ 393,554 $ 370,996 $ 888,341
Unrealized gains (losses) from investments
Unrealized holding gains (losses) arising
during the period (7,514) 10,947 (19,391) (3,262)
Reclassification adjustment for net (gains)
losses included in net income (13,498) 0 1,794 0
-------------- -------------- -------------- --------------
Change in net unrealized holding gains (losses) (21,012) 10,947 (17,597) (3,262)
-------------- -------------- -------------- --------------
Comprehensive income $ 239,161 $ 404,501 $ 353,399 885,079
============== ============== ============== ==============
</TABLE>
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
<PAGE> -5-
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
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 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 an 11.5% 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 an 11.5%
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. Property development and management fees
amounted to $701 in 1998 (none for the quarter 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 respective Operating Partnerships
Limited partnerships agreement.
The General Partners are entitled to receive an asset management and
partnership administrative fee equal to 0.5% of invested assets per annum, the
first $50,000 of which will be paid each year with the balance payable only
during such years that a 6.5% annual return has been paid to investors on a
noncumulative basis. An additional fee equal to 0.5% of invested assets per
annum will be payable only during those years that an 11.5% annual return has
been paid to investors on a noncumulative basis. Any unpaid amounts will
accrue and be payable only after an 11.5% annual return to investors has been
paid on a cumulative basis and the investors have received the return of their
capital contributions. Asset management and partnership administration fees of
$83,000 were incurred during 1998 ($41,500 for the quarter ended June 30,
1998).
Amounts due to general partners and their affiliates consisted of the
following at June 30, 1998:
Unpaid property development and management fees $ 112,492
Operating deficit and construction loans 807,854
Unpaid asset management and partnership administrative fees 83,000
--------------
$ 1,003,346
==============
Substantially all of the Partnership's general and administrative expenses 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
$515,967 ($161,147 for the quarter ended June 30, 1998). The 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 The Ponds at Georgetown. The fees for services
provided were $20,137 for 1998 ($10,113 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.
<PAGE> -6-
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
5. Partnership Reserve Account
The Partnership maintains a reserve account which consisted of the following
at June 30, 1998.
Cash and temporary cash investments $ (2,929)
GNMA Certificates 579,194
--------------
$ 576,265
==============
The reserve account was established to maintain working capital for the
Partnership and is available to supplement distributions to investors or for
other contingencies related to the ownership of investments and the operation
of the Partnership. The GNMA Certificates mature between 2008 and 2009. At
June 30, 1998, the total amortized cost, gross unrealized holding gains and
aggregate fair value of available-for-sale securities were $554,580, $24,614
and $579,194, respectively.
In May of 1998, the Partnership sold mortgage-backed securities with a
carrying Value of $360,146 for $374,711, thereby recognizing a gain of $14,565
on the sale.
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 II,
Inc., it can influence 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 $5,666,483 ($1.40 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 II L.P.-A
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 $ 654,703 $ 1,240,992
Investment in FHA Loan 6,522,514 6,538,424
Investment in GNMA Certificates 21,149,726 21,674,940
Investment in Operating Partnerships (5,666,483) (5,454,621)
Interest receivable 206,813 213,024
Other assets 129,638 162,154
-------------- --------------
$ 22,996,911 $ 24,374,913
============== ==============
Liabilities and Partners' Capital
Liabilities
Accounts payable $ 237,017 $ 327,513
Distribution payable 546,968 546,968
-------------- --------------
783,985 874,481
-------------- --------------
Partners' Capital 22,212,926 23,500,432
-------------- --------------
$ 22,996,911 $ 24,374,913
============== ==============
</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 $ 1,237,723 $ 1,252,549
Interest income on temporary cash investments 19,317 52,614
Equity in losses of Operating Partnerships (211,862) (118,159)
Other income 2,700 1,550
Gain on sale of mortgage-backed securities 14,565 -
-------------- --------------
1,062,443 1,188,554
Expenses
Operating and administrative 691,447 300,213
-------------- --------------
Net income $ 370,996 $ 888,341
============== ==============
</TABLE>
<PAGE> -8-
CAPITAL SOURCE II L.P.-A
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 $ 370,996 $ 888,341
Adjustments to reconcile net income to net cash
from operating activities
Equity in losses of Operating Partnerships 211,862 118,159
Amortization 31,188 31,188
Gain on sale of mortgage-backed securities (14,565) -
Other non-cash adjustments (83,994) (104,539)
-------------- --------------
Net cash provided by operating activities 515,487 933,149
-------------- --------------
Cash flows from investing activities
FHA Loan and GNMA Certificate principal payments 164,418 128,508
Proceeds from sale of mortgage-backed securities 374,711 -
Investment in Operating Partnerships - (121,450)
-------------- --------------
Net cash provided by investing activities 539,129 7,058
-------------- --------------
Cash flow used in financing activity
Distributions (1,640,905) (1,640,905)
-------------- --------------
Net decrease in cash and temporary cash investments (586,289) (700,698)
Cash and temporary cash investments at beginning of period 1,240,992 2,430,937
-------------- --------------
Cash and temporary cash investments at end of period $ 654,703 $ 1,730,239
============== ==============
</TABLE>
7. 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 I L.P., 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-
CAPITAL SOURCE II L.P.-A
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Liquidity and Capital Resources
The Partnership originally acquired: (i) four GNMA Certificates which are
guaranteed as to principal and interest by the Government National Mortgage
Association (GNMA) collateralized by first mortgage loans on multifamily
housing properties located in three states; (ii) an FHA Loan which is insured
as to principal and interest by the Federal Housing Administration (FHA) on a
multifamily housing property; and (iii) Partnership Equity Investments in five
Operating Partnerships which own the multifamily properties financed by the
GNMA Certificates and the FHA Loan. The Partnership has been repaid by GNMA
on one of the GNMA Certificates and the related property has been deeded to
GNMA in lieu of foreclosure, thus eliminating the Partnership Equity
Investment in such Property. Collectively, the remaining GNMA Certificates,
the FHA Loan, and the 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 Loan, 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 interest in each Operating Partnership,
and can influence decisions of the general partners in certain circumstances.
The following FHA Loan and GNMA Certificates were owned by the Partnership at
June 30, 1998. Interest income from the FHA Loan and GNMA Certificates is
the primary source of cash available for distribution to investors.
<TABLE>
<CAPTION>
Guaranteed Interest Maturity Principal
Property Name or Insured by Rate Date Balance
- ----------------------------------- --------------- ------------ -------------- --------------
<S> <C> <C> <C> <C>
Crane's Landing GNMA 8.75% 12-15-2030 $ 10,203,641
Delta Crossing FHA 9.10% 10-01-2030 6,522,514
Monticello Apartments GNMA 8.75% 11-15-2029 5,313,616
The Ponds at Georgetown GNMA 9.00% 12-15-2029 5,053,275
Pools of single-family mortgages GNMA 7.58% (1) 2008 to 2009 579,194
--------------
$ 27,672,240
==============
(1)Represents yield to the Partnership.
</TABLE>
<PAGE> -10-
CAPITAL SOURCE II L.P.-A
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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 monthly distributions
Income $ .0916 $ .2193
Return of capital .3134 .1857
-------------- --------------
$ .4050 $ .4050
============== ==============
Distributions
Paid out of cash flow $ .1922 $ .2879
Paid out of reserves .2128 .1171
-------------- --------------
$ .4050 $ .4050
============== ==============
</TABLE>
Regular monthly distributions to BAC Holders consist primarily of interest
received on the FHA Loan and GNMA Certificates and the Reserve Investments.
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, $862,441 was withdrawn from reserves to supplement
regular monthly cash distributions ($364,664 for the quarter ended June 30,
1997). The total amount held in reserves at June 30, 1998, was $576,265.
The Partnership has been supplementing cash flow from operations with
withdrawals from reserves in order to maintain distributions at current levels.
However, in light of available cash flow and reserves, the level of
distributions will be reduced effective with the distribution payable in
September. A reduction in the distribution is required so that cash provided
by operating activities and, if necessary, withdrawals from the Partnership's
reserves will be adequate to meet short-term liquidity requirements, including
the payments of distributions to BAC Holders. The Partnership has no other
internal or external sources of liquidity. Under the terms of its Partnership
Agreement, the Partnership has the authority to enter into short- 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 Loan 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.
<PAGE> -11-
CAPITAL SOURCE II L.P.-A
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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 II, 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 I, Inc. which currently serves as the special limited partner
representing the partnership interests of Capital Source I, 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 II, along with
Capital Source I, 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.
The following table shows the occupancy levels of the properties financed by
the Partnership as of June 30, 1998:
<TABLE>
<CAPTION>
Number Percentage
Number of Units of Units
Property Name Location of Units Occupied Occupied
- ------------------------------------- ------------------ --------- ---------- ----------
<S> <C> <C> <C> <C>
Crane's Landing Winter Park, FL 252 245 97%
Delta Crossing Charlotte, NC 178 164 92%
Monticello Apartments Southfield, MI 106 105 99%
The Ponds at Georgetown Ann Arbor, MI 134 131 98%
--------- ---------- ----------
670 645 96%
========= ========== ==========
</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 $ 1,286,571 $ 1,249,784 $ 36,787
Interest income on temporary cash investments 10,291 26,758 (16,467)
Mortgage-backed securities income 14,492 20,785 (6,293)
Other income 41,738 51,018 (9,280)
Gain on sale of mortgage backed securities 14,565 - 14,565
-------------- --------------- --------------
1,367,657 1,348,345 19,312
-------------- --------------- --------------
Real estate operating expenses 655,490 628,200 27,290
Depreciation 165,919 165,983 (64)
Investor servicing 135,515 77,034 58,481
Professional fees 75,200 10,550 64,650
Other expenses 6,150 3,905 2,245
Asset management and partnership administration fees 41,500 41,500 -
Amortization 27,783 27,800 (17)
-------------- --------------- --------------
1,107,557 954,972 152,585
-------------- --------------- --------------
Minority interest in losses of Operating Partnerships 73 181 (108)
-------------- --------------- --------------
Net income $ 260,173 $ 393,554 $ (133,381)
============== =============== ==============
</TABLE>
<PAGE> -12-
CAPITAL SOURCE II L.P.-A
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
<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 $ 2,546,469 $ 2,507,224 $ 39,245
Interest income on temporary cash investments 26,991 56,729 (29,738)
Mortgage-backed securities income 33,373 42,269 (8,896)
Other income 81,992 95,539 (13,547)
Gain on sale of mortgage-backed securities 14,565 - 14,565
-------------- -------------- --------------
2,703,390 2,701,761 1,629
-------------- -------------- --------------
Real estate operating expenses 1,284,192 1,157,158 127,034
Depreciation 331,834 331,965 (131)
Property development and management fees 701 - 701
Investor servicing 255,135 155,394 99,741
Professional fees 271,762 22,200 249,562
Other expenses 50,362 8,431 41,931
Asset management and partnership administration fees 83,000 83,000 -
Amortization 55,571 55,600 (29)
-------------- -------------- --------------
2,332,557 1,813,748 518,809
-------------- -------------- --------------
Minority interest in losses of Operating Partnerships 163 328 (165)
-------------- -------------- --------------
Net income $ 370,996 $ 888,341 $ (517,345)
============== ============== ==============
</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 $9,578 for the quarter and decreased $87,629 for
the six months ended June 30, 1998, respectively, compared to the same periods
in 1997. Rental income increased for the quarter and six months ended
June 30, 1998, compared to the same period in 1997, primarily due to increases
in rental revenue at Delta Crossing and at Monticello Apartments. These
increases resulted primarily from increases in average occupancy. The
increase in rental income for the quarter was partially offset by an overall
increase in real estate operating expenses. The increase in rental income for
the six months was more than offset by an increase in real estate operating
expenses primarily due to increases in repairs and maintenance expenses and
property improvements at Crane's Landing and increases in taxes, insurance and
other administrative costs at several of the Partnership's properties.
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
withdrawals made from the Partnership's reserves to supplement distributions to
BAC Holders.
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.
Other income consists primarily of income such as corporate unit rentals,
garage rentals, washer/dryer and vending income generated by the Partnership's
properties. Other income decreased for the quarter and six months ended June
30, 1998, respectively, compared to the same periods in 1997, due primarily to
a decrease in corporate unit rentals.
During the quarter and six months ended June 30, 1998, the Partnership
recorded a gain of $14,565 on the sale of mortgage-backed securities held in
its reserves. No such sale or gain occurred during the comparable periods in
1997.
<PAGE> -13-
CAPITAL SOURCE II L.P.-A
Investor servicing costs increased for the quarter and six months ended June
30, 1998, compared to the same periods in 1997, due primarily to increases in
salaries and related expenses. Salaries and related expenses increased as
additional management time was incurred in conjunction with the proposed
merger described in Note 7 to the consolidated financial statements.
Excluding costs of $66,300 and $252,800 incurred in connection with the
proposed merger, for the quarter and six months ended June 30, 1998,
respectively, 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.
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 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-
CAPITAL SOURCE II L.P.-A
PART II. OTHER INFORMATION
Item 5. Other Information
On May 7th, 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 L.P., 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 II
L.P.-A (incorporated herein by reference from Exhibit A of
the Prospectus contained in the Registrant's Post Effective
Amendment No. 4 dated February 5, 1987, to the Registration
Statement on Form S-11 (Commission File No. 0-16862)).
4(b) Beneficial Assignment Certificate (incorporated by
reference from Exhibit 10(a) to the Registrant's Amendment
No. 2 dated January 27, 1987, to the Registration Statement
on Form S-11 (Commission File No. 0-16862)).
(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 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.
Dated: August 13, 1998 CAPITAL SOURCE II L.P.-A
By America First Capital
Source II, L.L.C., General
Partner of the Registrant
By /s/ Michael Thesing
Michael Thesing,
Vice President and
Principal Financial Officer
<PAGE> -16-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
CONSOLIDATED STATEMENTS
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 654,703
<SECURITIES> 579,194
<RECEIVABLES> 10,792
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,244,689
<PP&E> 27,541,908
<DEPRECIATION> (6,662,128)
<TOTAL-ASSETS> 25,274,527
<CURRENT-LIABILITIES> 1,852,815
<BONDS> 0
<COMMON> 0
0
0
<OTHER-SE> 22,212,926
<TOTAL-LIABILITY-AND-EQUITY> 25,274,527
<SALES> 0
<TOTAL-REVENUES> 2,703,390
<CGS> 0
<TOTAL-COSTS> 2,332,557
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 370,996
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 370,996
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
