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 September 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
BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
Sept. 30, 1998 Dec. 31, 1997
-------------- --------------
<S> <C> <C>
Assets
Cash and temporary cash investments, at cost which
approximates market value $ 458,703 $ 1,240,992
Investment in FHA Loan (Note 5) 6,514,280 6,538,424
Investment in GNMA Certificates (Note 5) 20,560,766 21,674,940
Investment in Operating Partnerships (Note 6) - -
Interest receivable 203,878 213,024
Other assets 114,044 162,154
-------------- --------------
$ 27,851,671 $ 29,829,534
============== ==============
Liabilities and Partners' Capital (Deficit)
Liabilities
Accounts payable (Note 7) $ 132,885 $ 327,513
Distribution payable (Note 4) 303,871 546,968
-------------- --------------
436,756 874,481
-------------- --------------
Partners' Capital (Deficit)
General Partner (292,309) (276,907)
Beneficial Assignment Certificate Holders
($6.91 per BAC in 1998 and $7.29 in 1997) 27,707,224 29,231,960
-------------- --------------
27,414,915 28,955,053
-------------- --------------
$ 27,851,671 $ 29,829,534
============== ==============
</TABLE>
CAPITAL SOURCE II L.P.-A
STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
For the For the For the Nine For the Nine
Quarter Ended Quarter Ended Months Ended Months Ended
Sept. 30, 1998 Sept. 30, 1997 Sept. 30, 1998 Sept. 30, 1997
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Income
Mortgage-backed securities income $ 606,852 $ 624,302 $ 1,844,575 $ 1,876,851
Interest income on temporary cash investments 8,462 20,991 27,779 73,605
Equity in losses of Operating Partnerships (359,113) - (359,113) (121,450)
Other income 1,400 1,400 4,100 2,950
Gain on sale of mortgage-backed securities 38,535 - 53,100 -
--------------- --------------- --------------- ---------------
296,136 646,693 1,570,441 1,831,956
Expenses
Operating and administrative expenses (Note 7) 158,660 164,872 850,107 465,085
--------------- --------------- --------------- ---------------
Net income $ 137,476 $ 481,821 $ 720,334 $ 1,366,871
=============== =============== =============== ===============
Net income allocated to:
General Partners $ 1,375 $ 4,818 $ 7,203 $ 13,669
Limited Partners 136,101 477,003 713,131 1,353,202
--------------- --------------- --------------- ---------------
$ 137,476 $ 481,821 $ 720,334 $ 1,366,871
=============== =============== =============== ===============
Net income, basic and diluted, per BAC $ .03 $ .12 $ .18 $ .34
=============== =============== =============== ===============
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE> - 1 -
CAPITAL SOURCE II L.P.-A
STATEMENT OF PARTNERS' CAPITAL (DEFICIT)
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 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 $ (331,875) $ 23,790,096 $ 23,458,221
Effect of restatement (Note 2.H.) 54,546 5,400,075 5,454,621
-------------- ---------------- ---------------
Balance at December 31, 1997, as restated (277,329) 29,190,171 28,912,842
Net income 7,203 713,131 720,334
Cash distributions paid or accrued (Note 4) (22,183) (2,196,078) (2,218,261)
-------------- ---------------- ---------------
(292,309) 27,707,224 27,414,915
-------------- ---------------- ---------------
Net unrealized holding gains
Balance at December 31, 1997 422 41,789 42,211
Net change (422) (41,789) (42,211)
-------------- ---------------- ---------------
- - -
-------------- ---------------- ---------------
Balance at September 30, 1998 $ (292,309) $ 27,707,224 $ 27,414,915
============== ================ ===============
</TABLE>
CAPITAL SOURCE II L.P.-A
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
Sept. 30, 1998 Sept. 30, 1997
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities
Net income $ 720,334 $ 1,366,871
Adjustments to reconcile net income to net cash
from operating activities
Equity in losses of Operating Partnerships 359,113 121,450
Amortization of discount on mortgage-backed securities (1,422) (1,018)
Gain on the sale of mortgage-backed securities (53,100) -
Decrease in interest receivable 9,146 5,248
Decrease in other assets 48,110 46,003
Decrease in accounts payable (194,628) (62,210)
--------------- ---------------
Net cash provided by operating activities 887,553 1,476,344
--------------- ---------------
Cash flows from investing activities
FHA Loan and GNMA Certificate principal payments received 235,617 189,488
Disposition of available for sale mortgage-backed securities 915,012 -
Investment in Operating Partnerships (359,113) (121,450)
--------------- ---------------
Net cash provided by investing activities 791,516 68,038
--------------- ---------------
Cash flow used in financing activity
Distributions paid (2,461,358) (2,461,357)
--------------- --------------
Net decrease in cash and temporary cash investments (782,289) (916,975)
Cash and temporary cash investments at beginning of period 1,240,992 2,430,937
--------------- ---------------
Cash and temporary cash investments at end of period $ 458,703 $ 1,513,962
=============== ===============
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE> - 2 -
CAPITAL SOURCE II L.P.-A
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 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 was formed to invest principally in federally-insured
mortgages on multifamily housing properties and limited partnership interests
in 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 Michigan; and, (ii) one each in Florida and
North Carolina.
CS Properties II, Inc. which is owned by 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 II, Inc. also
serves as a co-general partner of The Ponds at Georgetown.
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 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
September 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> - 3 -
CAPITAL SOURCE II L.P.-A
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 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 Partnership 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
Partnerships 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 (4,011,101) 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 nine months
ended September 30, 1998, compared to the same periods in 1997 was as
follows:
<TABLE>
<CAPTION>
For the For the For the Nine For the Nine
Quarter Ended Quarter Ended Months Ended Months Ended
Sept. 30, 1998 Sept. 30, 1997 Sept. 30, 1998 Sept. 30, 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net income $ 137,476 $ 481,821 $ 720,334 $ 1,366,871
Unrealized gains (losses) from investments
Unrealized holding gains (losses) arising
during the period 30,280 9,350 10,889 6,088
Reclassification adjustment for net (gains)
losses included in net income (54,894) - (53,100) -
-------------- -------------- -------------- --------------
Change in net unrealized holding gains (losses) (24,614) 9,350 (42,211) 6,088
-------------- -------------- -------------- --------------
Comprehensive income $ 112,862 $ 491,171 $ 678,123 $ 1,372,959
============== ============== ============== ==============
<PAGE> - 4 -
CAPITAL SOURCE II L.P.-A
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
H) Restatement
The Partnership holds a majority ownership interest and through CS
Properties II, 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 1997 financial
statements have been restated to deconsolidate the Operating Partnerships
and to account for the investments in Operating Partnerships under the
equity method of accounting rather than consolidation.
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
$5,454,621, which was the negative balance of the Investment in Operating
Partnerships at that date. The restatement further increased net income
for the quarter and nine months ended September 30, 1997, by $135,023 and
$131,732 respectively. The restatement increased net income per BAC by
$.03 for each the quarter and nine months ended September 30, 1997
respectively.
</TABLE>
3. Partnership Reserve Account
The Partnership maintains a reserve account which consisted of the following
at September 30, 1998.
Cash and temporary cash investments $ 163,749
==============
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 Partnership's investment in mortgage-backed
securities and the operation of the Partnership.
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
Partners. Certain fees payable to the General Partners 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 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.
<PAGE> - 5 -
CAPITAL SOURCE II L.P.-A
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 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 September 30, 1998, there were no available-for-sale securities. At
September 30, 1998, the total amortized cost, gross unrealized holding gains
and aggregate fair value of held-to-maturity mortgage-backed securities were
$27,075,046, $414,516 and $27,489,562, respectively.
During May and August of 1998, the Partnership sold available-for-sale
mortgage-backed securities with an amortized cost of $861,912 for $915,012,
thereby recognizing a gain of $53,100 on the sale.
Descriptions of the Partnership's mortgage-backed securities at September 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:
Crane's Landing Winter Park, FL 252 8.75% 12-15-2030 $ 10,190,372
Monticello Apartments Southfield, MI 106 8.75% 11-15-2029 5,305,957
The Ponds at Georgetown Ann Arbor, MI 134 9.00% 12-15-2029 5,064,437
---------------
20,560,766
FHA Loan:
Delta Crossing Charlotte, NC 178 9.10% 10-01-2030 6,514,280
---------------
Balance at September 30, 1998 $ 27,075,046
===============
</TABLE>
(1) Represents yield to the Partnership.
Reconciliation of the carrying amount of the mortgage-backed securities is as
follows:
<TABLE>
<S> <C>
Balance at December 31, 1997 $ 28,213,364
Addition
Amortization of discount on mortgage-backed securities 1,422
Deductions
FHA Loan and GNMA Certificate principal payments received (235,617)
Disposition of available-for-sale mortgage backed securities (861,912)
Change in net unrealized holding gains (42,211)
---------------
Balance at September 30, 1998 $ 27,075,046
===============
</TABLE>
<PAGE> - 6 -
CAPITAL SOURCE II L.P.-A
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
6. Investment in Operating Partnerships
The Partnership's Investment in Operating Partnerships consist of interests in
limited partnerships which own multifamily properties financed by the GNMA
Certificates and FHA Loan 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 held at September 30, 1998, are as
follows:
<TABLE>
<CAPTION>
Carrying
Name Location Partnership Name Amount
- - ------------------------ --------------------- ----------------------------------------- ------------
<S> <C> <C> <C>
Delta Crossing Charlotte, NC Delta Crossing Limited Partnership $ -
Crane's Landing Winter Park, FL Crane's Landing Partnership, Ltd. -
Monticello Apartments Southfield, MI Centrum Monticello Limited Partnership -
The Ponds at Georgetown Ann Arbor, MI Ponds at Georgetown Limited Partnership -
------------
Balance at September 30, 1998 $ -
============
</TABLE>
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 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. As a result of a reduction in the level of
distributions effective with the distribution payable in October, less than
6.5% annual return will be paid to investors during 1998. Accordingly, the
asset management and partnership administration fee has been reduced from
$166,000 to $50,000 annually. Asset management and partnership administration
fees of $37,500 were incurred during 1998.
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
$635,082 ($119,115 for the quarter ended September 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 The Ponds at Georgetown. The fees for services
provided were $30,720 for 1998 ($10,583 for the quarter ended September 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> - 7 -
CAPITAL SOURCE II L.P.-A
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
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 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 investors 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> - 8 -
CAPITAL SOURCE II L.P.-A
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
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.
Distributions
Cash distributions paid or accrued per BAC were as follows:
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
Sept. 30, 1998 Sept. 30, 1997
-------------- --------------
<S> <C> <C>
Regular monthly distributions
Income $ .1778 $ .3374
Return of capital .3697 .2701
-------------- --------------
$ .5475 $ .6075
============== ==============
Distributions
Paid out of cash flow $ .3361 $ .4257
Paid out of reserves .2114 .1818
-------------- --------------
$ .5475 $ .6075
============== ==============
</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 nine months
ended September 30, 1998, $856,415 was withdrawn from reserves to supplement
regular monthly cash distributions ($6,026 was placed in reserves for the
quarter ended September 30, 1998). The total amount held in reserves at
September 30, 1998, was $163,749.
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 was reduced effective with the distribution for the month of
August payable in October. A reduction in the distribution was 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.
<PAGE> - 9 -
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 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 settlement agreement was executed on September 30, 1998
whereby the unaffiliated general partners of the Operating Partnership which
owns The Ponds at Georgetown agreed to withdraw from the Operating Partnership
effective as of June 1, 1998. CS Properties II, Inc., which is owned by the
General Partners of the Partnership and serves as a special limited partner
for such Operating Partnership, became a substitute general partner along with
CS Properties I, Inc. which 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. In addition, in
September of 1998, the mortgage loan to the Operating Partnership was modified
by increasing the outstanding principal amount to the original principal
amount and lowering the interest rate. In conjunction with the settlement
agreement and the restructuring of the Operating Partnership's mortgage loan,
the Partnership made an additional equity contribution of $359,113 to the
Operating Partnership in September of 1998. The additional equity
contribution was primarily used to pay outstanding taxes on the property.
Cash flow from the property is now anticipated to be sufficient to cover all
of the Operating Partnership's cash needs, including mortgage payments and
taxes. As a result of the restructuring of the mortgage loan, the
Partnership's and Capital Source I's GNMA Certificate related to the Ponds at
Georgetown was repaid and a new GNMA Certificate was issued in October of
1998. The interest rate on the reissued GNMA Certificate is 7.85% compared to
the repaid GNMA Certificate of 9%. Although the Partnership will receive less
interest on the reissued GNMA Certificate, the General Partners believe that
the restructuring described herein will better position the Operating
Partnership to provide future equity returns to the Partnership.
The overall status of the Partnership's other investments has remained
relatively constant since June 30, 1998.
The following table shows the occupancy levels of the properties financed by
the Partnership as of September 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 252 242 96%
Delta Crossing Charlotte, NC 178 167 94%
Monticello Apartments Southfield, MI 106 106 100%
The Ponds at Georgetown Ann Arbor, MI 134 132 99%
--------- ---------- ----------
670 647 97%
========= ========== ==========
</TABLE>
<PAGE> - 10 -
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)
Sept. 30, 1998 Sept. 30, 1997 From 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
Mortgage-backed securities income $ 606,852 $ 624,302 $ (17,450)
Interest income on temporary cash investments 8,462 20,991 (12,529)
Equity in losses of Operating Partnerships (359,113) - (359,113)
Other income 1,400 1,400 -
Gain on sale of mortgage-backed securities 38,535 - 38,535
--------------- --------------- ---------------
296,136 646,693 (350,557)
Operating and administrative expenses 158,660 164,872 (6,212)
--------------- --------------- ---------------
Net income $ 137,476 $ 481,821 $ (344,345)
=============== =============== ===============
</TABLE>
<TABLE>
<CAPTION>
For the Nine For the Nine Increase
Months Ended Months Ended (Decrease)
Sept. 30, 1998 Sept. 30, 1997 From 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
Mortgage-backed securities income $ 1,844,575 $ 1,876,851 $ (32,276)
Interest income on temporary cash investments 27,779 73,605 (45,826)
Equity in losses of Operating Partnerships (359,113) (121,450) (237,663)
Other income 4,100 2,950 1,150
Gain on sale of mortgage-backed securities 53,100 - 53,100
--------------- --------------- ---------------
1,570,441 1,831,956 (261,515)
Operating and administrative expenses 850,107 465,085 385,022
--------------- --------------- ---------------
Net income $ 720,334 $ 1,366,871 $ (646,537)
=============== =============== ===============
</TABLE>
Mortgage-backed securities income decreased for the quarter and nine months
ended September 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.
Interest income on temporary cash investments decreased for the quarter and
nine months ended September 30, 1998, compared to the same periods in 1997,
due to withdrawals made from the Partnership's reserves to supplement
distributions to BAC Holders.
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. During the quarter and nine months ended September 30, 1998,
the Partnership made additional investments in Operating Partnerships of
$359,113. The Partnership recorded equity in losses of Operating
Partnerships, for the respective periods to the extent of the additional
investments. Additional investments in Operating Partnerships were also made
were made during the nine months ended September 30, 1997 of $121,450. No
additional investments or equity in losses were recorded for the quarter ended
September 30, 1998.
During the quarter and nine months ended September 30, 1998, the Partnership
recorded a gain of $38,535 and $53,100, respectively, on the sale of
mortgage-backed securities held in its reserves. No such sale or gain
occurred during the comparable periods in 1997.
<PAGE> - 11 -
Operating and administrative expenses decreased $6,212 for the quarter and
increased $385,022 for the nine months ending September 30, 1998,
respectively, compared to the same periods in 1997. Approximately $252,800 of
such increase for the nine months ended September 30, 1998, respectively, was
due to costs incurred in connection with the proposed merger described in Note
8 to the financial statements. The remaining increase for the nine months was
due primarily to increases in salaries and related expenses, consulting fees
and travel expenses offset by the reduction in asset management and
partnership administration fee.
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 Loan,
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
assess their Year 2000 readiness. If a material third party vender 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 vender to the extent
practical.
<PAGE> - 12 -
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 is
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 Loan 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 Loan, 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> - 13 -
Forward Looking Statements
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 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 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 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> - 14 -
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 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
Dated: November 16, 1998
<PAGE> - 15 -
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 458,703
<SECURITIES> 27,075,046
<RECEIVABLES> 203,878
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 27,851,671
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 27,851,671
<CURRENT-LIABILITIES> 436,756
<BONDS> 0
<COMMON> 0
0
0
<OTHER-SE> 27,414,915
<TOTAL-LIABILITY-AND-EQUITY> 27,851,671
<SALES> 0
<TOTAL-REVENUES> 1,570,441
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 850,107
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 720,334
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 720,334
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
