<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarter Ended March 31, 1996
----------------------
Commission file number 1-9793
----------------------
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
-------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 52-1483643
- ----------------------------------------- ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11200 Rockville Pike, Rockville, Maryland 20852
- ----------------------------------------- ------------------------
(Address of principal executive offices) (Zip Code)
(301) 468-9200
-------------------------------------------------------------------------
(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 and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of May 14, 1996, 2,280,000 Series I and 3,238,760 Series II Beneficial
Assignee Certificates were outstanding.
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1996
Page
----
PART I. Financial Information (Unaudited)
Item 1. Financial Statements
Balance Sheets - March 31, 1996
and December 31, 1995 . . . . . . . . . . . . . . . 1
Statements of Income - for the three
months ended March 31, 1996 and 1995 . . . . . . . . 2
Statements of Changes in Partners'
Capital (Deficit) - for the three months ended
March 31, 1996 . . . . . . . . . . . . . . . . . . . 4
Statements of Cash Flows - for the three
months ended March 31, 1996 and 1995 . . . . . . . . 5
Notes to Financial Statements . . . . . . . . . . . . 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . 27
PART II. Other Information
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . 38
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 42
Signature . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . . 44
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
---------------------
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
SERIES I SERIES II
-------------------------------- ------------------------------
As of As of As of As of
March 31, December 31, March 31, December 31,
1996 1995 1996 1995
------------ ------------ ------------ ------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Investment in mortgage revenue bonds $ 30,740,285 $ 30,740,285 $ 43,793,252 $ 43,793,252
Cash and cash equivalents 453,646 58,924 125,544 88,986
Marketable securities 381,572 1,315,182 929,015 1,512,281
Working capital reserves invested in
marketable securities 1,318,280 1,284,670 2,273,911 2,307,385
Receivables and other assets 15,916 21,958 25,338 36,996
------------ ------------ ------------ ------------
Total assets $ 32,909,699 $ 33,421,019 $ 47,147,060 $ 47,738,900
============ ============ ============ ============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
Distributions payable $ 650,672 $ 1,243,762 $ 948,823 $ 1,766,776
Accounts payable and accrued expenses 210,500 198,413 234,499 224,135
------------ ------------ ------------ ------------
Total liabilities 861,172 1,442,175 1,183,322 1,990,911
------------ ------------ ------------ ------------
Partners' capital (deficit):
General Partner (213,379) (214,083) (287,629) (289,808)
Beneficial Assignee Certificates
(BACs) - issued and outstanding,
2,280,000 of Series I BACs and
3,238,760 of Series II BACs 32,261,906 32,192,927 46,251,367 46,037,797
------------ ------------ ------------ ------------
Total partners' capital 32,048,527 31,978,844 45,963,738 45,747,989
------------ ------------ ------------ ------------
Total liabilities and
partners' capital $ 32,909,699 $ 33,421,019 $ 47,147,060 $ 47,738,900
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part
of these financial statements.
-1-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
---------------------
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
SERIES I
------------------------------
For the three months ended
March 31,
1996 1995
----------- -----------
<S> <C> <C>
Interest from mortgage revenue bonds $ 831,102 $ 793,196
----------- -----------
Other income (expenses):
Other interest income 21,846 12,323
Merger-related expenses (76,039) --
General and administrative (34,263) (50,626)
Professional fees (22,291) (11,360)
----------- -----------
(110,747) (49,663)
----------- -----------
Net income $ 720,355 $ 743,533
=========== ===========
Net income allocated to General Partner (1.01%) $ 7,276 $ 7,510
=========== ===========
Net income allocated to BAC Holders (98.99%) $ 713,079 $ 736,023
=========== ===========
Net income per BAC $ 0.31 $ 0.32
=========== ===========
BACs outstanding 2,280,000 2,280,000
=========== ===========
</TABLE>
The accompanying notes are an integral part
of these financial statements.
-2-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
---------------------
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
SERIES II
------------------------------
For the three months ended
March 31,
1996 1995
----------- -----------
<S> <C> <C>
Interest from mortgage revenue bonds $ 1,269,063 $ 1,050,508
----------- -----------
Other income (expenses):
Other interest income 41,033 23,032
Merger-related expenses (76,039) --
General and administrative (38,952) (60,962)
Professional fees (30,533) (14,095)
----------- -----------
(104,491) (52,025)
----------- -----------
Net income $ 1,164,572 $ 998,483
=========== ===========
Net income allocated to General Partner (1.01%) $ 11,762 $ 10,085
=========== ===========
Net income allocated to BAC Holders (98.99%) $ 1,152,810 $ 988,398
=========== ===========
Net income per BAC $ 0.36 $ 0.31
=========== ===========
BACs outstanding 3,238,760 3,238,760
=========== ===========
</TABLE>
The accompanying notes are an integral part
of these financial statements.
-3-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
---------------------
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
For the three months ended March 31, 1996
(Unaudited)
<TABLE>
<CAPTION>
SERIES I
----------------------------------------------
Beneficial
Assignee
Certificate General
Holders Partner Total
------------ ----------- ------------
<S> <C> <C> <C>
Balance, December 31, 1995 $ 32,192,927 $ (214,083) $ 31,978,844
Net income 713,079 7,276 720,355
Distributions paid or accrued of $0.25 per BAC
(none of which is return of capital) (644,100) (6,572) (650,672)
------------ ----------- ------------
Balance, March 31, 1996 $ 32,261,906 $ (213,379) $ 32,048,527
============ =========== ============
SERIES II
----------------------------------------------
Beneficial
Assignee
Certificate General
Holders Partner Total
------------ ----------- ------------
<S> <C> <C> <C>
Balance, December 31, 1995 $ 46,037,797 $ (289,808) $ 45,747,989
Net income 1,152,810 11,762 1,164,572
Distributions paid or accrued of $0.29 per BAC
(none of which is return of capital) (939,240) (9,583) (948,823)
------------ ----------- ------------
Balance, March 31, 1996 $ 46,251,367 $ (287,629) $ 45,963,738
============ =========== ============
</TABLE>
The accompanying notes are an integral part
of these financial statements.
-4-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
---------------------
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
SERIES I
------------------------------
For the three months ended
March 31,
1996 1995
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 720,355 $ 743,533
Adjustments to reconcile net income to net cash provided by
operating activities:
Decrease in receivables and other assets 6,042 9,860
Increase (decrease) in accounts payable and accrued expenses 12,087 (15,653)
----------- -----------
Net cash provided by operating activities 738,484 737,740
----------- -----------
Cash flows from investing activities:
Sale of marketable securities 933,610 1,111,451
Purchase of marketable securities -- (585,532)
Deposits to working capital reserves invested in marketable
securities (33,610) (115,531)
----------- -----------
Net cash provided by investing activities 900,000 410,388
----------- -----------
Cash flows from financing activities:
Distributions to BAC Holders and General Partner (1,243,762) (1,151,631)
----------- -----------
Net increase (decrease) in cash and cash equivalents 394,722 (3,503)
Cash and cash equivalents, beginning of period 58,924 103,864
----------- -----------
Cash and cash equivalents, end of period $ 453,646 $ 100,361
=========== ===========
</TABLE>
The accompanying notes are an integral part
of these financial statements.
-5-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
---------------------
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
SERIES II
------------------------------
For the three months ended
March 31,
1996 1995
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,164,572 $ 998,483
Adjustments to reconcile net income to net cash provided by
operating activities:
Decrease (increase) in receivables and other assets 11,658 (780)
Increase (decrease) in accounts payable and accrued expenses 10,364 (24,092)
----------- -----------
Net cash provided by operating activities 1,186,594 973,611
----------- -----------
Cash flows from investing activities:
Sale of marketable securities 1,616,740 2,706,685
Purchase of marketable securities (1,033,474) (2,101,712)
Withdrawals from (deposits to) working capital reserves
invested in marketable securities 33,474 (32,609)
----------- -----------
Net cash provided by investing activities 616,740 572,364
----------- -----------
Cash flows from financing activities:
Distributions to BAC Holders and General Partner (1,766,776) (1,635,903)
----------- -----------
Net increase (decrease) in cash and cash equivalents 36,558 (89,928)
Cash and cash equivalents, beginning of period 88,986 101,283
----------- -----------
Cash and cash equivalents, end of period $ 125,544 $ 11,355
=========== ===========
</TABLE>
The accompanying notes are an integral part
of these financial statements.
-6-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
In the opinion of CRITEF Associates Limited Partnership (the General
Partner), the accompanying unaudited financial statements of Capital Realty
Investors Tax Exempt Fund Limited Partnership (the Partnership) contain all
adjustments of a normal recurring nature necessary to present fairly the
Partnership's financial position as of March 31, 1996 and December 31, 1995, and
the results of its operations for the three months ended March 31, 1996 and 1995
and its cash flows for the three months ended March 31, 1996 and 1995.
These unaudited financial statements have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and note disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted. While the General Partner believes that the disclosures
presented are adequate to make the information not misleading, it is suggested
that these financial statements be read in conjunction with the amended and
restated financial statements and notes included in the Partnership's Annual
Report filed on Form 10-K/A on May 17, 1996 for the year ended December 31,
1995.
The financial statements for the three months ended March 31, 1995 have
been restated to conform to 1996 presentation, as well as to conform with the
restated 1995 financial statements as discussed in Note 3.
2. MERGER PROPOSAL
On September 11, 1995, the Partnership and its General Partner entered into
a merger agreement, subject to BAC Holder approval, with an affiliate of Capital
Apartment Properties, Inc. (CAPREIT), a private real estate investment trust.
An affiliate of CAPREIT is the property manager for four of the five properties
securing the bonds held by Series I, and all five properties securing the bonds
in Series II. All nine properties managed by an affiliate of CAPREIT are
presently in default with respect to their mortgage loans held by the
Partnership. If the merger proposal is approved by a majority vote of BAC
Holders, all of the BACs in both Series I and Series II will be redeemed for
cash and the interests represented by such BACs will be canceled. On January
31, 1996, the agreement for the proposed merger was modified for the first time
to improve the terms of the original proposal. Under the original proposal, the
redemption amount per BAC was to be $13.761 and $13.313 for Series I and Series
II, respectively. Under the first modified agreement, the redemption amount per
BAC for Series I was to be $14.4096, subject to adjustment but not less than
$14.2713 or greater than $14.5479. The modified redemption amount per BAC for
Series II was to be $14.1597, subject to adjustment but not less than $14.0152
or greater than $14.3042. On March 14, 1996, the merger agreement was modified
for the second time to round the expected redemption amount per BAC for Series I
from $14.4096 to $14.41. The redemption amount per BAC for Series I is subject
to adjustment for available cash as defined in the amended merger agreement, but
not less than $14.27 or greater than $14.55. The merger agreement was also
modified to improve the redemption amount per BAC for Series II from $14.1597 to
$14.24, subject to adjustment for available cash, but not less than $14.10 or
greater than $14.38. In addition, the redemption amounts for Series I and
Series II will be reduced by the amount of court approved legal fees and
expenses awarded to counsel of the plaintiffs in the putative class action suits
naming the Partnership and others, as described below. Such legal fees and
expenses are not expected to exceed $0.16 and $0.20 per BAC for Series I and
Series II, respectively.
-7-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
2. MERGER PROPOSAL - Continued
The BAC Holders will also vote upon the removal of the Partnership's
General Partner immediately prior to consummation of the proposed merger and the
election in its stead of a newly-formed wholly-owned subsidiary of CAPREIT.
CAPREIT has agreed to pay the General Partner $500,000 in consideration for its
1.01% general partner interest in the Partnership.
CAPREIT and/or its designee will also acquire accounts receivables held by
CRI and CRIIMI MAE Services Limited Partnership (CRIIMI), for the accrued
mortgage servicing and administration fees on certain property mortgage loans of
both Series I and Series II. The general partner of CRIIMI is a subsidiary of
CRIIMI MAE Inc., a publicly-traded company affiliated with the General Partners.
Under the second modified agreement, CAPREIT will pay the discounted amount of
$511,680 and $770,835 to CRI for the fees of Series I and Series II,
respectively, accrued through June 30, 1996. The amounts to be paid to CRI
represent approximately 42% of the total accrued fees owed to CRI. Also,
CAPREIT will pay $265,968 and $391,296 to CRIIMI for the fees of Series I and
Series II, respectively, accrued from July 1, 1995 through June 30, 1996 which
represents 100% of the fees which are expected to be owed to CRIIMI for that
period. If the closing of the proposed merger does not occur by June 30, 1996,
the amounts to be paid by CAPREIT to CRIIMI will increase, to reflect additional
amounts currently being accrued for mortgage servicing and administration fees,
at a rate of $22,164 and $32,608 per month for Series I and Series II,
respectively.
Each of the affiliates of the Partnership formed to take title to the
properties subject to the existing indebtedness (Owner Partnerships) has agreed
to either (a) sell, assign and transfer the partnership interests in, or the
real property and other assets of, such Owner Partnerships to CAPREIT or its
designee for no additional consideration or (b) admit CAPREIT or its designee as
the managing general partner, whereupon the general partner interests of the
current general partners will be converted into limited partner interests, and
CAPREIT will have the option to acquire all of the limited partner interests at
any time within five years from the closing date of the merger at the then fair
market value thereof (defined as the proportionate interest of such limited
partner in the fair market value of the partnership property as encumbered by
the mortgage loans). Although such interests currently have nominal value, if
the fair market value of the partnership properties increases prior to the time
CAPREIT exercises its option, such increase in value may benefit the owners of
the Owner Partnership. This feature is required by CAPREIT as a condition of
the merger.
Consummation of the merger is contingent upon the approval of a majority of
combined Series I and Series II BAC Holders, voting together as one class. The
proposed merger is also contingent upon receiving a favorable opinion regarding
the fairness of the redemption amount to BAC Holders from a financial point of
view. Favorable opinions from an independent investment banking firm were
issued on March 14, 1996. A proxy statement is expected to be issued to BAC
Holders after it is filed with and clearance is received by the SEC. A
preliminary proxy statement was filed with the SEC on March 18, 1996. The
definitive proxy materials include a full description of the proposed merger and
the independent fairness opinion.
-8-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
3. INVESTMENTS
In May 1993, the Financial Accounting Standards Board (FASB) issued
Statement on Financial Accounting Standards No. 115 "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS 115). This statement requires
that most investments in securities be classified into one of the following
investment categories based upon circumstances under which securities might be
sold: Held to Maturity, Available for Sale, and Trading. Generally,
investments in securities for which an enterprise has both the ability and the
intent to hold to maturity should be accounted for using the amortized cost
method and all other securities must be recorded at their fair values. The
Partnership implemented SFAS 115 in 1994 for its marketable securities.
Following such adoption, the Partnership (as did others in the industry)
continued to account for its investments in mortgage revenue bonds, except
Observatory II, as investments in real estate based on consolidation of the
Owner Partnerships in accordance with the SEC rules.
In conjunction with the review of the Partnership's 1995 financial
statements by the Securities and Exchange Commission (SEC) staff, the
Partnership agreed to account for all of its investments in mortgage revenue
bonds as debt securities under the provisions of SFAS 115 effective January 1,
1994, and restate its 1995 and 1994 financial statements to reflect this change.
Accordingly, effective January 1, 1994, all investments in mortgage revenue
bonds are classified and accounted for as held to maturity securities and
carried at amortized cost because of the Partnership's ability and intent to
hold these investments to maturity. In accordance with SFAS 115's provisions
for held to maturity securities, the Partnership evaluates the fair value of its
mortgage revenue bonds to determine if impairment exists. If a decline in fair
value is determined to be other-than-temporary, the security is written down to
its fair value. The Partnership did not recognize any impairment losses during
the three months ended March 31, 1996 or 1995. Since all of the mortgage
revenue bonds, except Observatory II, are in default, base interest and
contingent interest on the mortgage revenue bonds is recognized as revenue when
collected.
The restatement of the 1995 financial statements resulted in increases of
$417,326 and $572,941 in the previously reported net income for Series I and
Series II, respectively, and increases of $0.18 in each of the previously
reported net income per BAC amounts for Series I and Series II, respectively,
for the first quarter of 1995. Net income per BAC as previously reported for
the three months ended March 31, 1995 was $0.14 and $0.13 for Series I and
Series II, respectively.
SERIES I
--------
The five original Series I mortgage loans securing the mortgage revenue
bonds, with current aggregate principal and carrying amounts of $44,155,000 and
$30,740,285, respectively, went into default, resulting in title transfer by
actual foreclosures or deeds in lieu of foreclosure to Owner Partnerships
subject to the existing indebtedness. In connection with the transfers of
properties to Owner Partnerships, the Partnership obtained an opinion from its
former independent accounting firm in July of 1991 that the reduction in pay
rate and compounding of unpaid base interest at the original base interest rate
would not cause a reissuance of the bonds under Section 103 of the Internal
Revenue Code of 1986, as amended (the Code) (which would cause the bonds to lose
their tax-exempt status). The Partnership also obtained opinions from bond
-9-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
3. INVESTMENTS - Continued
counsel that certain transfers of the properties to Owner Partnerships would not
cause the Partnership to become a substantial user of the projects or a related
party to a substantial user pursuant to Section 103 of the Code (which also
could have caused the bonds to lose their tax-exempt status). The bond counsel
opinions were obtained in connection with the Observatory II, Royal Oaks,
Trailway Pond and Valley Creek transfers.
In conjunction with the transfer of the Royal Oaks deed to an Owner
Partnership, the Royal Oaks mortgage revenue bond was modified. The Part-
nership, based on information and advice from outside counsel, believes that the
modification does not adversely affect the tax-exempt nature of the Royal Oaks
bond interest. The modification complied with IRS guidelines in effect at that
time. The IRS has since issued proposed regulations which could be interpreted
as adversely affecting the tax-exempt nature of the modified mortgage revenue
bond. However, the IRS has stated that the regulations will apply only to
modifications made on or after 30 days from the final publication of the
regulations in the Federal Register. As of May 14, 1996, the regulations have
not been finalized and no changes to these positions have been announced by the
IRS. The Partnership believes the interest on the Royal Oaks bond should
continue to be tax-exempt. However, there can be no assurance that interest
from the Royal Oaks bond will remain tax-exempt.
Presented below is a summary of base interest payments for the three months
ended March 31, 1996 and 1995 that are due to Series I from the borrowers:
-10-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
3. INVESTMENTS - Continued
<TABLE>
<CAPTION>
For the three months ended March 31, 1996
---------------------------------------------------------------
Base Interest Cumulative
Paid From Current Base Unpaid
Current Base Properties' Interest Full Base
Interest Due(1) Operations Not Paid Interest
--------------- ------------- ------------ -----------
<S> <C> <C> <C> <C>
Observatory II $ 32,000 $ 32,000 $ -- $ --
Royal Oaks 267,324 239,962 27,362 1,620,606
Trailway Pond 115,122 59,856 55,266 907,738
Valley Creek 331,588 252,078 79,510 2,830,691
White Bear Woods 327,731 247,206 80,525 2,081,276
----------- ----------- ---------- -----------
$ 1,073,765 $ 831,102 $ 242,663 $ 7,440,311
=========== =========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
For the three months ended March 31, 1995
---------------------------------------------------------------
Base Interest Cumulative
Paid From Current Base Unpaid
Current Base Properties' Interest Full Base
Interest Due(1) Operations Not Paid Interest
--------------- ------------- ------------ -----------
<S> <C> <C> <C> <C>
Observatory II $ 32,000 $ 32,000 $ -- $ --
Royal Oaks 267,324 213,415 53,909 1,416,382
Trailway Pond 115,122 63,194 51,928 688,760
Valley Creek 331,588 237,721 93,867 2,463,174
White Bear Woods 327,731 246,866 80,865 1,718,622
----------- ----------- ---------- -----------
$ 1,073,765 $ 793,196 $ 280,569 $ 6,286,938
=========== =========== ========== ===========
</TABLE>
(1) The Partnership charges the borrowers interest on unpaid base
interest, which totalled $225,483 and $176,696 for the three months
ended March 31, 1996 and 1995, respectively.
Contingent interest is recognized as revenue when collected. No contingent
interest was received or accrued by Series I during the three months ended March
31, 1996 or 1995. Contingent interest due for Series I as of March 31, 1996 and
December 31, 1995 amounted to $20,743,595 and $20,083,162, respectively.
As of March 31, 1996, Series I had cash and cash equivalents of $453,646,
unrestricted marketable securities of $381,572 and working capital reserves
invested in marketable securities of $1,318,280. Marketable securities consist
of tax-exempt municipal bonds which generally contain a seven-day put option
with established banks or brokerage houses. The Partnership has classified its
investments in marketable securities into the Available for Sale category under
-11-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
3. INVESTMENTS - Continued
SFAS 115. Realized gains and losses on the sale of marketable securities were
determined on a specific identification basis. There were no net unrealized
holding gains or losses recognized during the three months ended March 31, 1996
or 1995 for Series I as the cost for the tax-exempt municipal bonds approximated
market value throughout the respective periods.
SERIES II
---------
The five original Series II mortgage loans securing the mortgage revenue
bonds with aggregate principal and carrying amounts of $62,608,001 and
$43,793,252, respectively, went into default, resulting in deeds in lieu of
foreclosure, subject to the existing indebtedness, to Ownership Partnerships.
In connection with the transfers of properties to Owner Partnerships, the
Partnership obtained an opinion from its former independent accounting firm in
July of 1991 that the reduction in pay rate and compounding of unpaid base
interest at the original base interest rate would not cause a reissuance of the
bonds under Section 103 of the Code (which would cause the bonds to lose their
tax-exempt status). The Partnership also obtained opinions from bond counsel
that certain transfers of the properties to Owner Partnerships would not cause
the Partnership to become a substantial user of the projects or a related party
to a substantial user pursuant to Section 103 of the Code (which also could have
caused the bonds to lose their tax exempt status.) The bond counsel opinions
were obtained in connection with the Ethan's Ridge and Ethan's Glen IIB,
Fountain Place and Trailway Pond II transfers.
Presented below is a summary of base interest payments for the three months
ended March 31, 1996 and 1995 that are due to Series II from the borrowers:
-12-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
3. INVESTMENTS - Continued
<TABLE>
<CAPTION>
For the three months ended March 31, 1996
---------------------------------------------------------------
Base Interest Cumulative
Paid From Current Base Unpaid
Current Base Properties' Interest Full Base
Interest Due(1) Operations(2) Not Paid Interest
--------------- ------------- ------------ -----------
<S> <C> <C> <C> <C>
Ethan's Ridge and
Ethan's Glen IIB $ 379,688 $ 452,083 $ -- $ 1,929,798
Fountain Place 496,375 440,262 56,113 5,119,611
James Street
Crossing 333,939 224,664 109,275 1,804,446
Trailway Pond II 250,750 152,054 98,696 2,667,402
----------- ----------- ---------- -----------
$ 1,460,752 $ 1,269,063 $ 264,084 $11,521,257
=========== =========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
For the three months ended March 31, 1995
---------------------------------------------------------------
Base Interest Cumulative
Paid From Current Base Unpaid
Current Base Properties' Interest Full Base
Interest Due(1) Operations Not Paid Interest
--------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
Ethan's Ridge and
Ethan's Glen IIB $ 379,688 $ 310,916 $ 68,772 $ 1,767,296
Fountain Place 496,375 330,846 165,529 4,659,896
James Street
Crossing 333,939 261,980 71,959 1,501,688
Trailway Pond II 250,750 146,766 103,984 2,244,860
----------- ----------- ----------- -----------
$ 1,460,752 $ 1,050,508 $ 410,244 $10,173,740
=========== =========== =========== ===========
</TABLE>
(1) The Partnership charges the borrowers interest on unpaid base interest,
which totalled $336,025 and $274,821 for the three months ended March 31,
1996 and 1995, respectively.
(2) Includes amounts received by the Partnership in January 1996 from the
release of excess tax and insurance reserves relating to 1995. Such
amounts received from Ethan's Ridge and Ethan's Glen IIB, Fountain Place
and James Street Crossing totalled $107,000, $25,700 and $7,800,
respectively.
-13-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
Contingent interest is recognized as revenue when collected. No contingent
interest was received or accrued by Series II during the three months ended
March 31, 1996 or 1995. Contingent interest due for Series II as of March 31,
1996 and December 31, 1995 amounted to $28,941,111 and $27,897,543,
respectively.
As of March 31, 1996, Series II had cash and cash equivalents of $125,544,
unrestricted marketable securities of $929,015, and working capital reserves
invested in marketable securities of $2,273,911. Marketable securities consist
of tax-exempt municipal bonds which generally contain a seven-day put option
with established banks or brokerage houses. The Partnership has classified its
investments in marketable securities into the Available for Sale category under
SFAS 115. Realized gains and losses on the sale of marketable securities were
determined on a specific identification basis. There were no net unrealized
holding gains or losses recognized during the three months ended March 31, 1996
or 1995 for Series II as the cost for the tax-exempt municipal bonds
approximated market value throughout these periods.
SERIES I and II
---------------
In April 1991, the U.S. Supreme Court decided a case, Cottage Savings
Association V. Commissioner (Cottage Savings) that could be interpreted to
impact then existing authority addressing the modification of debt instruments.
In response to this decision in December 1992 the Internal Revenue Service
issued Proposed Regulation Section 1.1001-3 which specifically address the tax
consequences of modifications of debt instruments. Among other things, these
proposed regulations, if they become effective in their current form, would
provide that certain modifications of the current interest payments or maturity
date of a debt instrument will be treated as a taxable exchange of the original
instrument for the modified debt instrument. As a result of this treatment,
modifications of the mortgage loans which secure the mortgage revenue bonds
could be treated as a deemed reissuance of the mortgage revenue bonds for
federal income tax purposes. Any reissuance without the cooperation of the
mortgage revenue bond issuers would result in the loss of the tax-exempt status
of the mortgage revenue bonds. Such issuers might cooperate and consent to the
reissuance; however, there can be no assurance that such issuers would do so or
would not impose additional requirements that would have an adverse impact on
the properties.
Even if issuer consent were obtained, if the modifications are considered
material, the debt would have to be re-examined to determine whether it would
still be considered debt for tax purposes. This could result in a write-down of
principal, would most likely result in a write-off of all accrued and unpaid
past due interest and could change the contingent interest feature of the
existing mortgage loans. The write down of principal and unpaid interest would
not be recoverable upon ultimate disposition or payoff of the mortgage revenue
bond and would instead accrue to the benefit of the Owner Partnership to the
extent realized.
Proposed Regulation Section 1.001-3 will become effective only with respect
to modifications made on or after the date that is 30 days after the publication
of final regulations in the Federal Register. It is uncertain at this time when
this proposed regulation will be finalized and whether it will be finalized in
its current form. It is also unclear at this time what effect the Cottage
Savings decision may have on modifications that have been made to mortgage loans
which secure the mortgage revenue bonds or on modifications that might be
-14-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
appropriate in the future. The General Partner believes that the modifications
which have been made were consistent with the relevant tax authority which
existed at the time of those modifications and have not jeopardized the tax-
exempt status of the mortgage revenue bonds. However, there can be no assurance
as to the tax-exempt status of the mortgage revenue bonds.
The General Partner's ongoing strategy has been to continue holding the
mortgage revenue bonds until the loan maturity dates. If the merger proposal,
discussed in Note 2, is approved, the interests of the BAC Holders will be
redeemed for cash. If the merger proposal is not approved, in order to maximize
the overall yield, the General Partner may recommend, subject to satisfactory
resolution of any issues relating to the tax-exempt status of the mortgage
revenue bonds, for investor approval extension of certain loan maturity dates
and, if approved, arrange any necessary related amendments to the pertinent
mortgage revenue bonds.
4. DISTRIBUTIONS TO BAC HOLDERS
The Partnership expects to continue to make distributions to BAC Holders on
a semi-annual basis. The amended merger agreement stipulates that 1996
distributions cannot exceed $0.09417 and $0.09667 per BAC per month for Series I
and Series II, respectively. There are no other legal restrictions on the
Partnership's present or future ability to make cash distributions other than as
set forth in the amended merger agreement. However, property level reserves are
depleted and estimated cash flows from the properties' operations are
insufficient to pay full monthly base interest (except for Observatory II in
Series I), therefore, the distribution to BAC Holders may fluctuate from current
levels. The General Partner seeks to optimize cash flow from the properties
owned by the Owner Partnerships. Despite these efforts, the amounts paid to the
Partnership from the borrowers may be expected to fluctuate from period to
period due to changes in occupancy rates, rental rates, operating expenses and
other variables.
SERIES I
--------
The following distributions were paid or accrued to BAC Holders of record
during the three months ended March 31, 1996 and 1995:
-15-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
4. DISTRIBUTIONS TO BAC HOLDERS - Continued
<TABLE>
<CAPTION>
1996 1995
Distributions to Distributions to
BAC Holders BAC Holders
----------------------------- -----------------------------
Quarter Ended Total Per BAC Total Per BAC
- ------------- --------- ------- --------- -------
<S> <C> <C> <C> <C>
March 31, $ 644,100 $0.2825 $ 615,600 $0.2700
========= ======= ========= =======
</TABLE>
Distributions to BAC Holders for the three months ended March 31, 1996 and
1995 were funded as follows:
<TABLE>
<CAPTION>
For the three months ended
March 31,
------------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Cash Available for Distribution:
Cash flow (1) $ 684,282 $ 737,412
Net deposits to working capital reserves (33,610) (115,531)
------------ ------------
Total cash available for distribution $ 650,672 $ 621,881
============ ============
Distributions to:
General partner (1.01%) $ 6,572 $ 6,281
============ ============
BAC Holders (98.99%) $ 644,100 $ 615,600
============ ============
</TABLE>
(1) Defined in the Limited Partnership Agreement as (a) all revenues received
by the Partnership during such period, plus (b) any amounts which the
Managing General Partner releases from the Working Capital Reserve as being
no longer necessary to hold as part of the Working Capital Reserve, plus
(c) any amounts released to the Partnership from the Interest Reserve
Account with respect to a mortgaged property after completion of
construction of such mortgaged property, less (i) operating expenses of the
Partnership paid from reserves during the period, including any expenses
paid to the General Partner, but not including such amounts paid from the
Working Capital Reserve, (ii) all cash payments made from Revenues during
such period to discharge Partnership indebtedness, and (iii) all amounts
from revenues, if any, added to the Working Capital Reserve during such
period. Cash flow as defined in the Limited Partnership Agreement is not
to be construed as an alternative to operating income in accordance with
generally accepted accounting principles (GAAP) as an indication of the
Partnership's operating performance.
-16-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
4. DISTRIBUTIONS TO BAC HOLDERS - Continued
The Partnership's working capital reserves are available for the payment of
ongoing costs of operating and administering the Partnership's business, for
supplementing distributions to BAC Holders and for making working capital loans
to borrowers. Working capital reserves for Series I were $1,318,280 and
$1,284,670 as of March 31, 1996 and December 31, 1995, respectively. None of
the distributions made to BAC Holders during the first quarter of 1996 or 1995
was funded from the working capital reserves. During the three months ended
March 31, 1996 and 1995, working capital reserves were increased by $33,610 and
$115,531, respectively, from surplus operating cash.
SERIES II
---------
The following distributions were paid or accrued to BAC Holders of record
during the three months ended March 31, 1996 and 1995:
-17-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
4. DISTRIBUTIONS TO BAC HOLDERS - Continued
<TABLE>
<CAPTION>
1996 1995
Distributions to Distributions to
BAC Holders BAC Holders
----------------------------- -----------------------------
Quarter Ended Total Per BAC Total Per BAC
- ------------- --------- ------- --------- -------
<S> <C> <C> <C> <C>
March 31, $ 939,240 $0.2900 $ 874,465 $0.2700
========= ======= ========= =======
</TABLE>
Distributions to BAC Holders for the three months ended March 31, 1996 and
1995 were funded as follows:
<TABLE>
<CAPTION>
For the three months ended
March 31,
------------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Cash Available for Distribution:
Cash flow (1) $ 915,349 $ 915,996
Net withdrawals from (deposits to) working capital reserves 33,474 (32,609)
------------ ------------
Total cash available for distribution $ 948,823 $ 883,387
============ ============
Distributions to:
General partner (1.01%) $ 9,583 $ 8,922
============ ============
BAC Holders (98.99%) $ 939,240 $ 874,465
============ ============
</TABLE>
(1) Defined in the Limited Partnership Agreement as (a) all revenues received
by the Partnership during such period, plus (b) any amounts which the
Managing General Partner releases from the Working Capital Reserve as being
no longer necessary to hold as part of the Working Capital Reserve, plus
(c) any amounts released to the Partnership from the Interest Reserve
Account with respect to a mortgaged property after completion of
construction of such mortgaged property, less (i) operating expenses of the
Partnership paid from reserves during the period, including any expenses
paid to the General Partner, but not including such amounts paid from the
Working Capital Reserve, (ii) all cash payments made from Revenues during
such period to discharge Partnership indebtedness, and (iii) all amounts
from revenues, if any, added to the Working Capital Reserve during such
period. Cash flow as defined in the Limited Partnership Agreement is not
to be construed as an alternative to operating income in accordance with
GAAP as an indication of the Partnership's operating performance.
-18-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
4. DISTRIBUTIONS TO BAC HOLDERS - Continued
Working capital reserves for Series II were $2,273,911 and $2,307,385 as of
March 31, 1996 and December 31, 1995, respectively. Of the total distributions
made to BAC Holders during the first quarter of 1996, $33,474 was funded from
the working capital reserves. During the three months ended March 31, 1995,
working capital reserves were increased by $32,609 from surplus operating cash.
5. INCOME TAXES
For income tax purposes, base interest income is accrued when earned. The
accrual of base interest is discontinued when, at the time of accrual, ultimate
collectibility of the base interest due is considered unlikely. Once a loan has
been placed in a non-accrual status, income is recorded only as cash payments
are received from the borrower until such time as the uncertainty of collection
of unpaid base interest is eliminated. All loans except Observatory II were on
non-accrual status throughout the three months ended March 31, 1996 and 1995;
therefore, for income tax purposes, income was recognized to the extent of cash
received. Contingent interest from the investment is recognized as revenue when
collected. No contingent interest was recognized for the three months ended
March 31, 1996 or 1995.
For federal income tax purposes, the investments in all of the mortgage
revenue bonds are treated as loans, interest on which is exempt from regular
federal income tax. A reconciliation of the primary differences between the
financial statement net income and municipal income for tax purposes is as
follows:
-19-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
5. INCOME TAXES - Continued
<TABLE>
<CAPTION>
SERIES I
--------
For the three months ended
March 31,
1996 1995
----------- -----------
<S> <C> <C>
Financial statement net income $ 720,355 $ 743,533
Adjustment for timing of municipal income recognition (36,075) (6,120)
---------- ----------
Municipal income, net for tax purposes $ 684,280 $ 737,413
========== ==========
Municipal income per BAC outstanding $ 0.30 $ 0.32
========== ==========
</TABLE>
<TABLE>
<CAPTION>
SERIES II
---------
For the three months ended
March 31,
1996 1995
----------- -----------
<S> <C> <C>
Financial statement net income $ 1,164,572 $ 998,483
Adjustment for timing of municipal income recognition (249,226) (82,489)
----------- -----------
Municipal income, net for tax purposes $ 915,346 $ 915,994
=========== ===========
Municipal income per BAC outstanding $ 0.28 $ 0.28
=========== ===========
</TABLE>
A publicly traded partnership is treated as a corporation for income tax
purposes unless it meets certain exceptions. To qualify under these exceptions,
the General Partner annually invests in de minimus taxable investments for both
Series I and Series II.
6. LITIGATION
On September 22, 1995, Irving Zakin commenced a putative class action (the
Zakin Action) against the Partnership, its general partner (CRITEF Associates
Limited Partnership), its Assignor Limited Partner (CRITEF, Inc.), CRI, William
B. Dockser, H. William Willoughby, Capital Realty Investors Tax Exempt Fund III
Limited Partnership, CRITEF III Associates Limited Partnership, CRITEF III,
Inc., and CAPREIT (collectively, the Defendants) in the court of Chancery of the
State of Delaware in New Castle County (the Chancery Court) (C.A. No. 14558).
The complaint alleges, among other things, that the amount offered to the BAC
Holders in the proposed merger at the time the complaint was filed was
-20-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
6. LITIGATION - Continued
inadequate, and that the Defendants breached their fiduciary duty to the BAC
Holders, or aided and abetted such a breach, engaged in self-dealing and misled
BAC Holders, in connection with the proposed merger. The suit seeks to enjoin
the proposed merger, to obtain damages in an unspecified amount for the BAC
Holders, and to compel the Defendants to maximize the amount paid to the BAC
Holders and consider unspecified alternatives to the proposed merger.
On October 5, 1995, David and Johanna Wingard (the Wingard Action)
commenced a second putative class action against the Defendants in the Chancery
Court (C.A. No 14604). The complaint in the Wingard Action contains virtually
the identical allegations and seeks virtually the identical relief as in the
Zakin Action. A request to the Court has been made by the plaintiffs in both
lawsuits to consolidate the two actions.
On January 31, 1996, the Defendants and the plaintiffs and their respective
attorneys reached a tentative settlement of the purported class actions which is
memorialized in a Memorandum of Understanding (the Memorandum), dated as of such
date. The proposed settlement must be approved by the Chancery Court. The
Memorandum contemplates the complete discharge, settlement and release of all
claims that have been, could have been, or in the future might be asserted in
any action or any other proceeding in connection with the proposed merger. The
parties to the Memorandum will use their best efforts to execute an appropriate
Stipulation of Settlement (the Stipulation) and such other documents as may be
required in order to obtain approval by the Chancery Court of the settlement.
The Defendants have denied, and continue to deny, that any of them have
committed or threatened to commit any violations of law or breaches of duty to
the BAC Holders. The Defendants have entered into the Memorandum solely because
the proposed settlement would eliminate the burden and expense of further
litigation and would facilitate the consummation of the proposed merger, which
the General Partner believes to be in the best interest of the BAC Holders.
In accordance with the Memorandum, the agreements for the proposed merger
were amended to provide for the revised merger terms, as previously discussed
above. Pursuant to the Memorandum, the plaintiffs' counsel will be entitled to
apply to the Court for an award of reasonable attorneys' fees and expenses.
Such expenses are not expected to exceed $0.16 and $0.20 per BAC for Series I
and Series II, respectively. These fees will reduce the redemption amounts to
BAC Holders in connection with the proposed merger, as discussed. In the event
that the proposed merger is not consummated, these fees will not be borne by the
Partnership. As such, the Partnership's financial statements do not include any
adjustment for these fees.
Counsel for the plaintiffs have reviewed certain documents relating to the
proposed mergers, and will have the opportunity to review and take depositions
of representatives of the General Partner and CAPREIT. After such review,
counsel for the plaintiffs shall have the right to terminate the settlement
contemplated in the Memorandum, based on material information not presently
available to them.
After the Stipulation is executed, the parties will seek preliminary
approval of the settlement by the Chancery Court and will then mail notice of
the proposed settlement to members of the putative class. As soon as
practicable following completion of the discovery described in the preceding
paragraph and after class members have had a period of time to review the notice
-21-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
6. LITIGATION - Continued
of proposed settlement, the parties will use their best efforts to obtain final
Chancery Court approval of the settlement and the dismissal of the class actions
as to all of the claims.
On November 9, 1995, CRI filed a complaint against Capital Management
Strategies, Inc. (CMS), a company controlled by Martin C. Schwartzberg, to
determine the proper amount of fees to be paid in 1996 under an asset management
agreement. CMS answered on January 10, 1996, but asserted no counterclaims.
Thereafter, Mr. Schwartzberg launched a hostile consent solicitation to be
designated as managing general partner of approximately 125 private partnerships
sponsored by CRI. Mr. Schwartzberg is a former shareholder and executive
officer of CRI who decided to leave the company as of January 1, 1990. In
connection with his departure, he relinquished his general partner duties for
all CRI-sponsored partnerships, including those of the General Partner. On
March 28, 1996, Mr. Schwartzberg filed a preliminary proxy statement with the
SEC opposing the proposed merger.
On January 18, 1996, Mr. Schwartzberg and CMS filed a complaint in the
Circuit Court of Montgomery County, Maryland (the Circuit Court), against CRI
and Messrs. Dockser and Willoughby alleging, among other things, (i) that CRI
and Messrs. Dockser and Willoughby have breached an asset management agreement
pursuant to which Mr. Schwartzberg's company, CMS, agreed to perform limited
functions related to property-level issues for a portion of CRI's subsidized
housing portfolio (but not properties securing the mortgage revenue bonds) by
reducing the proposed budget for 1996, (ii) that the actions of CRI and Messrs.
Dockser and Willoughby in connection with the proposed merger involve self-
dealing and constitute a breach of their fiduciary duties to Mr. Schwartzberg,
and (iii) that the actions in connection with the merger of CRIIMI MAE Inc. in
June, 1995 involved self-interest and led in part to the proposed reduction of
the asset management agreement budget. Neither of the Partnership nor the
General Partner was named as a defendant in this action, and Mr. Schwartzberg
does not allege that he is a BAC Holder. Messrs. Dockser and Willoughby have
entered an answer denying all of Mr. Schwartzberg's claims and moving to strike
the allegations concerning the Partnership and CRIIMI MAE Inc. and dismiss the
related counts for failure to state a claim upon which relief can be granted.
Messrs. Dockser and Willoughby have publicly responded that Mr. Schwartzberg's
suit is motivated by his budget dispute with CRI and personal animosity.
On February 12, 1996, the Montgomery County Circuit Court issued a
memorandum opinion and order enjoining CMS and Mr. Schwartzberg from disclosing
information made confidential under the asset management agreement.
On February 15, 1996, Mr. Schwartzberg filed suit in the Chancery Court
against the General Partner and CRITEF III Associates Limited Partnership (No.
14837). He alleges that he has made demands upon the General Partner and CRITEF
III Associates Limited Partnership, in his capacity as a general and limited
partner of the General Partner and as a limited partner of CRITEF III Associates
Limited Partnership, to inspect and obtain copies of a current list of the BAC
holders and other documents. He further alleges that his demands were rejected.
On February 23, 1996, the General Partner and CRITEF III Associates Limited
Partnership answered the complaint, admitting that his demands have been
rejected and denying that Mr. Schwartzberg is entitled to the materials
requested because, among other things, he lacks standing and proper purpose to
inspect and obtain copies of the requested materials. A hearing was held on
-22-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
6. LITIGATION - Continued
March 6 and 7, 1996 and it is expected that the Chancery Court will render a
decision following submission of briefs by the parties.
On February 16, 1996, the Partnership, together with the General Partner,
Capital Realty Investors Tax Exempt Fund III Limited Partnership and its general
partner, CRI, and CAPREIT (collectively, the Plaintiffs) filed suit against Mr.
Schwartzberg in the United States District Court for the Southern District of
New York (the District Court), No. 96 Civ. 1186 (LAK) (the New York Action).
The complaint alleges that Mr. Schwartzberg is engaged in an unlawful
solicitation of proxies of the BAC Holders through two press releases he issued
in violation of the federal securities laws and rules promulgated by the SEC
requiring definitive proxy materials to be filed with the SEC and delivered to
the BAC Holders. The complaint also alleges that Mr. Schwartzberg has made
false and misleading statements in the solicitations concerning the terms of the
proposed merger and the availability of certain financial information, and has
falsely imputed base motives to the principals of the General Partner. On
February 23, 1996, the District Court, without making a finding of fact, issued
a temporary restraining order barring Mr. Schwartzberg from making any
solicitation of the BAC Holders without first complying with the SEC rules
pending a hearing on a proposed preliminary injunction. The District Court held
a hearing on March 5, 1996, on the motion of preliminary injunction, and,
pending a decision, continued the temporary restraining order.
On March 18, 1996, the District Court issued its Opinion enjoining Mr.
Schwartzberg from (1) making any further solicitation of BAC Holders without
complying with the provisions of Regulation 14A under the Securities Exchange
Act of 1934, and (2) committing any violation of Rule 14a-9 (regarding false or
misleading statements) in connection with any solicitation relating to the
Partnerships. The injunction was based on the District Court's findings of fact
and conclusions of law, in which it stated that the Plaintiffs (including the
Partnership) have established a strong likelihood of success on their claim that
the press releases constitute a proxy solicitation in violation of securities
laws and that the Plaintiffs are likely to establish that Mr. Schwartzberg acted
with the requisite culpability with respect to at least some of the false
statements made in his press releases. Also on March 18, 1996, Mr. Schwartzberg
filed his answer to the complaint in the New York action, coupled with
counterclaims against the General Partner alleging that three press releases
issued by the General Partner of the Partnership constituted solicitations in
violation of the same provisions of the Securities Exchange Act and that they
were false and misleading. The counter-defendants deny the allegations. The
counterclaims sought a temporary restraining order against the General Partners
regarding further alleged solicitations and false and misleading statements.
The District Court denied the injunction request by order on April 23, 1996. On
April 16, 1996, Mr. Schwartzberg also filed a Notice of Appeal with respect to
the injunction against him with the U. S. Court of Appeals for the Second
Circuit.
The Partnership Agreement provides for the indemnification of the General
Partners and its affiliates for acts or omissions by the General Partner in good
faith and in the best interest of the Partnership. Such indemnification does
not extend to a finding of liability for conduct which constitutes fraud, bad
faith, misconduct, breach of fiduciary duties, or violation of state or federal
securities laws. At this time, there is no estimate as to the timing or amount,
if any, of the outcome of the New York Action, but the General Partners do not
anticipate that the litigation will have a material adverse affect on the
-23-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
6. LITIGATION - Continued
Partnership.
7. RELATED-PARTY TRANSACTIONS
The General Partner has the authority and responsibility for, among other
things, the overall management and control of the Partnership. The General
Partner and its affiliates do not receive any fees from the Partnership for
their services to the Partnership, but are reimbursed by the Partnership for any
actual costs and expenses incurred in connection with the operation of the
Partnership.
SERIES I
--------
Expense reimbursements to an affiliate of the General Partner for the three
months ended March 31, 1996 and 1995 were $20,789 and $33,044, respectively, and
are included in general and administrative expense and merger-related expenses
in the statements of income.
CRICO Mortgage Company, Inc. (CRICO Mortgage), a former affiliate of the
General Partner, was entitled to annual mortgage administration and servicing
fees from the borrowers which were payable from operating revenues each month
after payment of full base interest on the mortgage loans. On June 30, 1995,
CRICO Mortgage merged with and into CRIIMI, an affiliate of CRIIMI MAE Inc., a
publicly traded real estate investment trust (the REIT). The REIT was
originally sponsored by CRI, a general partner of the General Partner, but is
not controlled by CRI, although the CRI stockholders are directors, officers and
major stockholders of the REIT. Pursuant to the REIT merger agreement, the
right to receive the accrued and unpaid mortgage administration and servicing
fees as of the date of the REIT merger was distributed by CRICO Mortgage to its
shareholders and contributed by them to CRI. After June 30, 1995, the mortgage
administration and servicing are being performed by CRIIMI, and mortgage
administration and servicing fees are payable to that entity. The merger did
not result in any increase in fees or changes in the amount of fees which are
currently payable.
The following unpaid fees were due to CRI and CRIIMI from the borrowers as
of March 31, 1996 and December 31, 1995:
-24-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
7. RELATED-PARTY TRANSACTIONS - Continued
<TABLE>
<CAPTION>
As of As of
March 31, December 31,
1996 1995
----------- ------------
<S> <C> <C>
CRI $ 1,225,393 $ 1,225,393
CRIIMI 200,309 133,817
----------- ------------
Total $ 1,425,702 $ 1,359,210
=========== ============
</TABLE>
The unpaid fees are payable from available cash flow after payment of all
current and delinquent base interest and accrued interest on delinquent base
interest. If available cash flow from the borrower is insufficient to pay the
fee, it is payable on the earlier of prepayment or maturity of the loan, after
debt repayment. Any payments made with respect to unpaid fees will be applied
against the oldest outstanding fees first.
In connection with the amended merger agreement entered into by the
Partnership, as discussed in Note 2, unpaid fees accrued through June 30, 1995
will be purchased by CAPREIT from CRI for the discounted amount of $511,680,
which represents approximately 42% of the total accrued fees owed to CRI. In
addition, unpaid fees accrued from July 1, 1995 through June 30, 1996 will be
purchased by CAPREIT from CRIIMI for $265,968, which represents 100% of the
accrued fees which are expected to be owed to CRIIMI for that period. The
proposed purchase price for CRIIMI's portion remains in effect until June 30,
1996. If the proposed merger is not consummated by such date, the purchase
price of CRIIMI's portion will be adjusted upward at a rate of $22,164 per
month.
Fees paid by the borrowers to CRI/CRICO Mortgage and CRIIMI for the three
months ended March 31, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
For the three months ended
March 31,
1996 1995
----------- -----------
<S> <C> <C>
CRI/CRICO Mortgage $ -- $ 2,500
CRIIMI 2,500 --
----------- -----------
Total $ 2,500 $ 2,500
=========== ===========
</TABLE>
Owner Partnerships formed to take title to properties, subject to the
existing indebtedness, are structured as limited partnerships. The Owner
Partnerships and the managing general partner of the General Partner have
primarily common ownership and are under common control. The Owner
Partnerships, rather than the Partnership, became holders of title to the
-25-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
7. RELATED-PARTY TRANSACTIONS - Continued
properties in an effort to maintain the tax-exempt nature of interest on the
mortgage revenue bonds and to hold the properties until their ultimate
disposition. No compensation or fees were paid by the Partnership to the Owner
Partnerships or their principals in connection with the transfers of ownership.
In connection with the amended merger agreement, each of the Owner
Partnerships has agreed to either (a) sell, assign and transfer the partnership
interests in, or the real property and other assets of, such Owner Partnerships
to CAPREIT or its designee for no additional consideration or (b) admit CAPREIT
or its designee as the managing general partner, whereupon the general partner
interests of the current general partners will be converted into limited partner
interests, and CAPREIT will have the option to acquire all of the limited
partner interests at any time within five years from the closing date of the
merger at the then fair market value (defined as the proportionate interest of
such limited partner in the fair market value of the partnership property as
encumbered by the mortgage loans) thereof. Although such interests currently
have nominal value, if the fair market value of the partnership properties
increases prior to the time CAPREIT exercises its option, such increase in value
may benefit the owners of the Owner Partnerships.
SERIES II
---------
Expense reimbursements to an affiliate of the General Partner for the three
months ended March 31, 1996 and 1995 were $24,027 and $37,613, respectively, and
are included in general and administrative expense and merger-related expenses
in the statements of income.
CRICO Mortgage, a former affiliate of the General Partner, was entitled to
annual mortgage administration and servicing fees from the borrowers which were
payable from operating revenues each month after payment of full base interest
on the mortgage loans. On June 30, 1995, CRICO Mortgage merged with and into
CRIIMI, an affiliate of the REIT. The REIT was originally sponsored by CRI, but
is not controlled by CRI, although the CRI stockholders are directors, officers
and major stockholders of the REIT. Pursuant to the REIT merger agreement, the
right to receive the accrued and unpaid mortgage administration and servicing
fees as of the date of the REIT merger was distributed by CRICO Mortgage to its
shareholders and contributed by them to CRI. After June 30, 1995, the mortgage
administration and servicing are being performed by CRIIMI and mortgage
administration and servicing fees are payable to that entity. This merger did
not result in any increase in fees or changes in the amount of fees which are
currently payable.
The following unpaid fees were due CRI and CRIIMI from the borrowers as of
March 31, 1996 and December 31, 1995:
-26-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
7. RELATED-PARTY TRANSACTIONS - Continued
<TABLE>
<CAPTION>
As of As of
March 31, December 31,
1996 1995
----------- ------------
<S> <C> <C>
CRI $ 1,847,496 $ 1,847,496
CRIIMI 293,472 195,648
----------- ------------
Total $ 2,140,968 $ 2,043,144
=========== ============
</TABLE>
The unpaid fees are payable from available cash flow after payment of all
current and delinquent base interest and accrued interest on delinquent base
interest. If available cash flow from the borrower is insufficient to pay the
fee, it is payable on the earlier of prepayment or maturity of the loan, after
debt repayment. Any payments made with respect to unpaid fees will be applied
against the oldest outstanding fees first. During the three months ended March
31, 1996 and 1995, no fees were paid by the borrowers.
In connection with the amended merger agreement entered into by the
Partnership, as discussed in Note 2, the unpaid fees accrued through June 30,
1995 will be purchased from CRI for the discounted amount of $770,835, which
represents approximately 42% of the total accrued fees owed to CRI. In
addition, unpaid fees accrued from July 1, 1995 through June 30, 1996 will be
purchased by CAPREIT from CRIIMI for $391,296, which represents 100% of the
accrued fees which are expected to be owed to CRIIMI for that period. The
proposed purchase price for CRIIMI's portion remains in effect until June 30,
1996. If the proposed merger is not consummated by such date, the purchase
price of CRIIMI's portion will be adjusted upward at a rate of $32,608 per
month.
Owner Partnerships formed to take title to properties, subject to existing
indebtedness, are structured as limited partnerships. The Owner Partnerships
and the managing general partner of the General Partner have primarily common
ownership (except for Ethan's Ridge and Ethan's Glen IIB prior to March 14,
1996, as discussed below) and are under common control. The Owner Partnerships,
rather than the Partnership, became holders of title to the properties in an
effort to maintain the tax-exempt nature of interest on the mortgage revenue
bonds and to hold the properties until their ultimate disposition. No
compensation or fees were paid by the Partnership to the Owner Partnerships in
connection with the transfers of ownership.
In connection with the amended merger agreement, each of the Owner
Partnerships has agreed to either (a) sell, assign and transfer the partnership
interests in, or the real property and other assets of, such Owner Partnerships
to CAPREIT or its designee for no additional consideration or (b) admit CAPREIT
or its designee as the managing general partner, whereupon the general partner
interests of the current general partners will be converted into limited partner
interests, and CAPREIT will have the option to acquire all of the limited
partner interests at any time within five years from the closing date of the
merger at the then fair market value (defined as the proportionate interest of
such limited partner in the fair market value of the partnership property as
-27-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
7. RELATED-PARTY TRANSACTIONS - Continued
encumbered by the mortgage loans) thereof. Although such interests currently
have nominal value, if the fair market value of the partnership properties
increases prior to the time CAPREIT exercises its option, such increase in value
may benefit the owners of the Owner Partnerships.
-28-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
Business
--------
The Partnership's Management's Discussion and Analysis of Financial
Condition and Results of Operations contains information that may be considered
forward looking. This information contains a number of risks and uncertainties,
as discussed herein and in the Partnership's Annual Report filed on Form 10-K/A,
that could cause actual results to differ materially.
In May 1993, the Financial Accounting Standards Board (FASB) issued
Statement on Financial Accounting Standards No. 115 "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS 115). This statement requires
that most investments in securities be classified into one of the following
investment categories based upon circumstances under which securities might be
sold: Held to Maturity, Available for Sale, and Trading. Generally,
investments in securities for which an enterprise has both the ability and the
intent to hold to maturity should be accounted for using the amortized cost
method and all other securities must be recorded at their fair values. The
Partnership implemented SFAS 115 in 1994 for its marketable securities.
Following such adoption, the Partnership (as did others in the industry)
continued to account for its investments in mortgage revenue bonds, except
Observatory II, as investments in real estate based on consolidation of the
Owner Partnerships in accordance with the SEC rules.
In conjunction with the review of the Partnership's 1995 financial
statements by the Securities and Exchange Commission (SEC) staff, the
Partnership agreed to account for all of its investments in mortgage revenue
bonds as debt securities under the provisions of SFAS 115 effective January 1,
1994, and restate its 1995 and 1994 financial statements to reflect this change.
Accordingly, effective January 1, 1994, all investments in mortgage revenue
bonds are classified and accounted for as held to maturity securities and
carried at amortized cost because of the Partnership's ability and intent to
hold these investments to maturity. In accordance with SFAS 115's provisions
for held to maturity securities, the Partnership evaluates the fair value of its
mortgage revenue bonds to determine if impairment exists. If a decline in fair
value is determined to be other-than-temporary, the security is written down to
its fair value. The Partnership did not recognize any impairment losses during
the three months ended March 31, 1996 or 1995. Since all of the mortgage
revenue bonds, except Observatory II, are in default, base interest and
contingent interest on the mortgage revenue bonds is recognized as revenue when
collected.
SERIES I
--------
The five original Series I mortgage loans securing the mortgage revenue
bonds, with current aggregate principal and carrying amounts of $44,155,000 and
$30,740,285, respectively, went into default, resulting in title transfer by
actual foreclosures or deeds in lieu of foreclosure to Owner Partnerships
subject to the existing indebtedness. In connection with the transfers of
properties to Owner Partnerships, the Partnership obtained an opinion from its
former independent accounting firm in July of 1991 that the reduction in pay
rate and compounding of unpaid base interest at the original base interest rate
would not cause a reissuance of the bonds under Section 103 of the Internal
Revenue Code of 1986, as amended (the Code) (which would cause the bonds to lose
their tax-exempt status). The Partnership also obtained opinions from bond
-29-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
counsel that certain transfers of the properties to Owner Partnerships would not
cause the Partnership to become a substantial user of the projects or a related
party to a substantial user pursuant to Section 103 of the Code (which also
could have caused the bonds to lose their tax-exempt status). The bond counsel
opinions were obtained in connection with the Observatory II, Royal Oaks,
Trailway Pond and Valley Creek transfers.
In conjunction with the transfer of the Royal Oaks deed to an Owner
Partnership, the Royal Oaks mortgage revenue bond was modified. The Part-
nership, based on information and advice from outside counsel, believes that the
modification does not adversely affect the tax-exempt nature of the Royal Oaks
bond interest. The modification complied with IRS guidelines in effect at that
time. The IRS has since issued proposed regulations which could be interpreted
as adversely affecting the tax-exempt nature of the modified mortgage revenue
bond. However, the IRS has stated that the regulations will apply only to
modifications made on or after 30 days from the final publication of the
regulations in the Federal Register. As of May 14, 1996, the regulations have
not been finalized and no changes to these positions have been announced by the
IRS. The Partnership believes the interest on the Royal Oaks bond should
continue to be tax-exempt. However, there can be no assurance that interest
from the Royal Oaks bond will remain tax-exempt.
SERIES II
---------
The five original Series II mortgage loans securing the mortgage revenue
bonds with aggregate principal and carrying amounts of $62,608,001 and
$43,793,252, respectively, went into default, resulting in deeds in lieu of
foreclosure, subject to the existing indebtedness, to Ownership Partnerships.
In connection with the transfers of properties to Owner Partnerships, the
Partnership obtained an opinion from its former independent accounting firm in
July of 1991 that the reduction in pay rate and compounding of unpaid base
interest at the original base interest rate would not cause a reissuance of the
bonds under Section 103 of the Code (which would cause the bonds to lose their
tax-exempt status). The Partnership also obtained opinions from bond counsel
that certain transfers of the properties to Owner Partnerships would not cause
the Partnership to become a substantial user of the projects or a related party
to a substantial user pursuant to Section 103 of the Code (which also could have
caused the bonds to lose their tax exempt status.) The bond counsel opinions
were obtained in connection with the Ethan's Ridge and Ethan's Glen IIB,
Fountain Place and Trailway Pond II transfers.
-30-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
SERIES I and II
---------------
In April 1991, the U.S. Supreme Court decided a case, Cottage Savings
Association V. Commissioner (Cottage Savings) that could be interpreted to
impact then existing authority addressing the modification of debt instruments.
In response to this decision in December 1992 the Internal Revenue Service
issued Proposed Regulation Section 1.1001-3 which specifically address the tax
consequences of modifications of debt instruments. Among other things, these
proposed regulations, if they become effective in their current form, would
provide that certain modifications of the current interest payments or maturity
date of a debt instrument will be treated as a taxable exchange of the original
instrument for the modified debt instrument. As a result of this treatment,
modifications of the mortgage loans which secure the mortgage revenue bonds
could be treated as a deemed reissuance of the mortgage revenue bonds for
federal income tax purposes. Any reissuance without the cooperation of the
mortgage revenue bond issuers would result in the loss of the tax-exempt status
of the mortgage revenue bonds. Such issuers might cooperate and consent to the
reissuance; however, there can be no assurance that such issuers would do so or
would not impose additional requirements that would have an adverse impact on
the properties.
Even if issuer consent were obtained, if the modifications are considered
material, the debt would have to be re-examined to determine whether it would
still be considered debt for tax purposes. This could result in a write-down of
principal, would most likely result in a write-off of all accrued and unpaid
past due interest and could change the contingent interest feature of the
existing mortgage loans. The write down of principal and unpaid interest would
not be recoverable upon ultimate disposition or payoff of the mortgage revenue
bond and would instead accrue to the benefit of the Owner Partnership to the
extent realized.
Proposed Regulation Section 1.001-3 will become effective only with respect
to modifications made on or after the date that is 30 days after the publication
of final regulations in the Federal Register. It is uncertain at this time when
this proposed regulation will be finalized and whether it will be finalized in
its current form. It is also unclear at this time what effect the Cottage
Savings decision may have on modifications that have been made to mortgage loans
which secure the mortgage revenue bonds or on modifications that might be
appropriate in the future. The General Partner believes that the modifications
which have been made were consistent with the relevant tax authority which
existed at the time of those modifications and have not jeopardized the tax-
exempt status of the mortgage revenue bonds. However, there can be no assurance
as to the tax-exempt status of the mortgage revenue bonds.
The General Partner's ongoing strategy has been to continue holding the
mortgage revenue bonds until the loan maturity dates. If the merger proposal,
discussed in Note 2, is approved, the interests of the BAC Holders will be
redeemed for cash. If the merger proposal is not approved, in order to maximize
the overall yield, the General Partner may recommend, subject to satisfactory
resolution of any issues relating to the tax-exempt status of the mortgage
revenue bonds, for investor approval extension of certain loan maturity dates
and, if approved, arrange any necessary related amendments to the pertinent
mortgage revenue bonds.
-31-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
Merger Proposal
- ---------------
On September 11, 1995, the Partnership and its General Partner entered into
a merger agreement, subject to BAC Holder approval, with an affiliate of Capital
Apartment Properties, Inc. (CAPREIT), a private real estate investment trust.
An affiliate of CAPREIT is the property manager for four of the five properties
securing the bonds held by Series I, and all five properties securing the bonds
in Series II. All nine properties managed by an affiliate of CAPREIT are
presently in default with respect to their mortgage loans held by the
Partnership. If the merger proposal is approved by a majority vote of BAC
Holders, all of the BACs in both Series I and Series II will be redeemed for
cash and the interests represented by such BACs will be canceled. On January
31, 1996, the agreement for the proposed merger was modified for the first time
to improve the terms of the original proposal. Under the original proposal, the
redemption amount per BAC was to be $13.761 and $13.313 for Series I and Series
II, respectively. Under the first modified agreement, the redemption amount per
BAC for Series I was to be $14.4096, subject to adjustment but not less than
$14.2713 or greater than $14.5479. The modified redemption amount per BAC for
Series II was to be $14.1597, subject to adjustment but not less than $14.0152
or greater than $14.3042. On March 14, 1996, the merger agreement was modified
for the second time to round the expected redemption amount per BAC for Series I
from $14.4096 to $14.41. The redemption amount per BAC for Series I is subject
to adjustment for available cash as defined in the amended merger agreement, but
not less than $14.27 or greater than $14.55. The merger agreement was also
modified to improve the redemption amount per BAC for Series II from $14.1597 to
$14.24, subject to adjustment for available cash, but not less than $14.10 or
greater than $14.38. In addition, the redemption amounts for Series I and
Series II will be reduced by the amount of court approved legal fees and
expenses awarded to counsel of the plaintiffs in the putative class action suits
naming the Partnership and others, as described below. Such legal fees and
expenses are not expected to exceed $0.16 and $0.20 per BAC for Series I and
Series II, respectively.
The BAC Holders will also vote upon the removal of the Partnership's
General Partner immediately prior to consummation of the proposed merger and the
election in its stead of a newly-formed wholly-owned subsidiary of CAPREIT.
CAPREIT has agreed to pay the General Partner $500,000 in consideration for its
1.01% general partner interest in the Partnership.
CAPREIT and/or its designee will also acquire accounts receivables held by
CRI and CRIIMI MAE Services Limited Partnership (CRIIMI), for the accrued
mortgage servicing and administration fees on certain property mortgage loans of
both Series I and Series II. The general partner of CRIIMI is a subsidiary of
CRIIMI MAE Inc., a publicly-traded company affiliated with the General Partners.
Under the second modified agreement, CAPREIT will pay the discounted amount of
$511,680 and $770,835 to CRI for the fees of Series I and Series II,
respectively, accrued through June 30, 1996. The amounts to be paid to CRI
represent approximately 42% of the total accrued fees owed to CRI. Also,
CAPREIT will pay $265,968 and $391,296 to CRIIMI for the fees of Series I and
Series II, respectively, accrued from July 1, 1995 through June 30, 1996 which
represents 100% of the fees which are expected to be owed to CRIIMI for that
period. If the closing of the proposed merger does not occur by June 30, 1996,
the amounts to be paid by CAPREIT to CRIIMI will increase, to reflect additional
amounts currently being accrued for mortgage servicing and administration fees,
at a rate of $22,164 and $32,608 per month for Series I and Series II,
-32-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
respectively.
Each of the affiliates of the Partnership formed to take title to the
properties subject to the existing indebtedness (Owner Partnerships) has agreed
to either (a) sell, assign and transfer the partnership interests in, or the
real property and other assets of, such Owner Partnerships to CAPREIT or its
designee for no additional consideration or (b) admit CAPREIT or its designee as
the managing general partner, whereupon the general partner interests of the
current general partners will be converted into limited partner interests, and
CAPREIT will have the option to acquire all of the limited partner interests at
any time within five years from the closing date of the merger at the then fair
market value thereof (defined as the proportionate interest of such limited
partner in the fair market value of the partnership property as encumbered by
the mortgage loans). Although such interests currently have nominal value, if
the fair market value of the partnership properties increases prior to the time
CAPREIT exercises its option, such increase in value may benefit the owners of
the Owner Partnership. This feature is required by CAPREIT as a condition of
the merger.
Consummation of the merger is contingent upon the approval of a majority of
combined Series I and Series II BAC Holders, voting together as one class. The
proposed merger is also contingent upon receiving a favorable opinion regarding
the fairness of the redemption amount to BAC Holders from a financial point of
view. Favorable opinions from an independent investment banking firm were
issued on March 14, 1996. A proxy statement is expected to be issued to BAC
Holders after it is filed with and clearance is received by the SEC. A
preliminary proxy statement was filed with the SEC on March 18, 1996. The
definitive proxy materials include a full description of the proposed merger and
the independent fairness opinion.
Financial Condition and Liquidity
---------------------------------
The primary sources of the Partnership's future cash flows are expected to
be from receipts of base interest on mortgage loans, which are dependent upon
the net operating income of the properties. Therefore, the Partnership's
investment in the mortgage revenue bonds is subject to the general risks
inherent to the ownership of real property. These risks include reduction in
rental income due to an inability to maintain occupancy levels, adverse changes
in general economic conditions, and adverse changes in local conditions. The
General Partner expects that the properties transferred to Owner Partnerships
will continue to generate sufficient cash flow to pay all operating expenses,
meet escrow deposit requirements and pay some, but not all, of the base interest
due to the Partnership. The Partnership has no material commitments for capital
expenditures.
SERIES I
--------
Series I expects to continue to make distributions to BAC Holders on a
semi-annual basis. The amended merger agreement stipulates that the 1996
distributions cannot exceed $0.09417 per BAC per month. There are no other
legal restrictions on Series I's present or future ability to make cash
distributions other than as set forth in the amended merger agreement. However,
property level reserves are depleted and estimated cash flows from the
properties' operations are insufficient to pay full monthly base interest
-33-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
(except for Observatory II), therefore, the distribution to BAC Holders may
fluctuate from current levels. The General Partner seeks to optimize cash flow
from the properties owned by Owner Partnerships. Despite these efforts, the
amounts paid to the Partnership from the borrowers may be expected to fluctuate
from period to period due to changes in occupancy rates, rental rates, operating
expenses and other variables. Based upon the current operations of the
Partnership, the General Partner expects the 1996 distribution to approximate
$1.13 per BAC, the maximum amount stipulated in the amended merger agreement.
The following distributions were paid or accrued to BAC Holders of record
during the three months ended March 31, 1996 and 1995:
-34-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
<TABLE>
<CAPTION>
1996 1995
Distributions to Distributions to
BAC Holders BAC Holders
----------------------------- -----------------------------
Quarter Ended Total Per BAC Total Per BAC
- ------------- --------- ------- --------- -------
<S> <C> <C> <C> <C>
March 31, $ 644,100 $0.2825 $ 615,600 $0.2700
========= ======= ========= =======
</TABLE>
Distributions to BAC Holders for the three months ended March 31, 1996 and
1995 were funded as follows:
<TABLE>
<CAPTION>
For the three months ended
March 31,
------------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Cash Available for Distribution:
Cash flow (1) $ 684,282 $ 737,412
Net deposits to working capital reserves (33,610) (115,531)
------------ ------------
Total cash available for distribution $ 650,672 $ 621,881
============ ============
Distributions to:
General partner (1.01%) $ 6,572 $ 6,281
============ ============
BAC Holders (98.99%) $ 644,100 $ 615,600
============ ============
</TABLE>
(1) Defined in the Limited Partnership Agreement as (a) all revenues received
by the Partnership during such period, plus (b) any amounts which the
Managing General Partner releases from the Working Capital Reserve as being
no longer necessary to hold as part of the Working Capital Reserve, plus
(c) any amounts released to the Partnership from the Interest Reserve
Account with respect to a mortgaged property after completion of
construction of such mortgaged property, less (i) operating expenses of the
Partnership paid from reserves during the period, including any expenses
paid to the General Partner, but not including such amounts paid from the
Working Capital Reserve, (ii) all cash payments made from Revenues during
such period to discharge Partnership indebtedness, and (iii) all amounts
from revenues, if any, added to the Working Capital Reserve during such
period. Cash flow as defined in the Limited Partnership Agreement is not
to be construed as an alternative to operating income in accordance with
generally accepted accounting principles (GAAP) as an indication of the
Partnership's operating performance.
-35-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
The General Partner expects the distribution for the six months ending June
30, 1996 to total approximately $0.565 per BAC, payable on August 29, 1996, or
possibly earlier depending on the merger closing date, payable to Series I BAC
Holders of record as of the last day in each month during this period.
The Partnership's working capital reserves are available for the payment of
ongoing costs of operating and administering the Partnership's business, for
supplementing distributions to BAC Holders and for making working capital loans
to borrowers. Working capital reserves invested in marketable securities for
Series I were $1,318,280 and $1,284,670 as of March 31, 1996 and December 31,
1995, respectively. None of the distributions made to BAC Holders during the
first quarter of 1996 or 1995 was funded from the working capital reserves.
During the three months ended March 31, 1996 and 1995, working capital reserves
were increased by $33,610 and $115,531, respectively, from surplus operating
cash.
As of March 31, 1996, Series I had cash and cash equivalents of $453,646
and unrestricted marketable securities of $381,572. Marketable securities
consist of tax-exempt municipal bonds which generally contain a seven-day put
option with established banks or brokerage houses. The Partnership has
classified its investments in marketable securities into the Available for Sale
category under SFAS 115. Realized gains and losses on the sale of marketable
securities were determined on a specific identification basis. There were no
net unrealized holding gains or losses recognized during the three months ended
March 31, 1996 or 1995 for Series I as the cost for the tax-exempt municipal
bonds approximated market value throughout the respective periods.
The Partnership closely monitors its cash flow and liquidity position for
Series I in an effort to ensure that sufficient cash is available for operating
requirements and distributions to BAC Holders. Series I's net cash provided by
operating activities, which consists primarily of receipt of base interest on
mortgage loans, for the three months ended March 31, 1996 was adequate to
support operating, investing and financing requirements and the declared
distributions to BAC Holders and the General Partner. The Partnership estimates
that future cash flows from receipt of base interest on mortgage loans, in the
aggregate, will be sufficient to pay operating expenses and make distributions
to BAC Holders and the General Partner.
SERIES II
---------
Series II expects to continue to make distributions to BAC Holders on a
semi-annual basis. The amended merger agreement stipulates that 1996
distributions cannot exceed $0.09667 per BAC per month. There are no other
legal restrictions on Series II's present or future ability to make cash
distributions other than as set forth in the amended merger agreement. However,
property level reserves are depleted and estimated cash flows from the
properties' operations are insufficient to pay full monthly base interest,
therefore, the distribution to BAC Holders may fluctuate from current levels.
The General Partner seeks to optimize cash flow from the properties owned by
Owner Partnerships. Despite these efforts, the amounts paid to the Partnership
from the borrowers may be expected to fluctuate from period to period due to
changes in occupancy rates, rental rates, operating expenses and other
variables. Based upon the current operations of the Partnership, the General
Partner expects the 1996 distribution to approximate $1.16 per BAC, the maximum
amount stipulated in the amended merger agreement.
-36-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
The following distributions were paid or accrued to BAC Holders of record
during the three months ended March 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
Distributions to Distributions to
BAC Holders BAC Holders
----------------------------- -----------------------------
Quarter Ended Total Per BAC Total Per BAC
- ------------- --------- ------- --------- -------
<S> <C> <C> <C> <C>
March 31, $ 939,240 $0.2900 $ 874,465 $0.2700
========= ======= ========= =======
</TABLE>
Distributions to BAC Holders for the three months ended March 31, 1996
and 1995 were funded as follows:
<TABLE>
<CAPTION>
For the three months ended
March 31,
------------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Cash Available for Distribution:
Cash flow (1) $ 915,349 $ 915,996
Net withdrawals from (deposits to) working
capital reserves 33,474 (32,609)
------------ ------------
Total cash available for distribution $ 948,823 $ 883,387
============ ============
Distributions to:
General partner (1.01%) $ 9,583 $ 8,922
============ ============
BAC Holders (98.99%) $ 939,240 $ 874,465
============ ============
</TABLE>
(1) Defined in the Limited Partnership Agreement as (a) all revenues received
by the Partnership during such period, plus (b) any amounts which the
Managing General Partner releases from the Working Capital Reserve as being
no longer necessary to hold as part of the Working Capital Reserve, plus
(c) any amounts released to the Partnership from the Interest Reserve
Account with respect to a mortgaged property after completion of
construction of such mortgaged property, less (i) operating expenses of the
Partnership paid from reserves during the period, including any expenses
paid to the General Partner, but not including such amounts paid from the
Working Capital Reserve, (ii) all cash payments made from Revenues during
such period to discharge Partnership indebtedness, and (iii) all amounts
from revenues, if any, added to the Working Capital Reserve during such
-37-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
period. Cash flow as defined in the Limited Partnership Agreement is not
to be construed as an alternative to operating income in accordance with
GAAP as an indication of the Partnership's operating performance.
The General Partner expects the distribution for the six months ending
March 31, 1996 to total approximately $0.58 per BAC, payable on August 29, 1996,
or possibly earlier depending on the merger closing date, payable to Series I
BAC Holders of record as of the last day in each month during this period.
Working capital reserves for Series II were $2,273,911 and $2,307,385 as of
March 31, 1996 and December 31, 1995, respectively. Of the total distributions
made to BAC Holders during the first quarter of 1996, $33,474 was funded from
the working capital reserves. During the three months ended March 31, 1995,
working capital reserves were increased by $32,609 from surplus operating cash.
As of March 31, 1996, Series II had cash and cash equivalents of $125,544,
unrestricted marketable securities of $929,015, and working capital reserves
invested in marketable securities of $2,273,911. Marketable securities consist
of tax-exempt municipal bonds which generally contain a seven-day put option
with established banks or brokerage houses. The Partnership has classified its
investments in marketable securities into the Available for Sale category under
SFAS 115. Realized gains and losses on the sale of marketable securities were
determined on a specific identification basis. There were no net unrealized
holding gains or losses recognized during the three months ended March 31, 1996
or 1995 for Series II as the cost for the tax-exempt municipal bonds
approximated market value throughout these periods.
The Partnership closely monitors its cash flow and liquidity position for
Series II in an effort to ensure that sufficient cash is available for operating
requirements and distributions to BAC Holders. Series II's net cash provided by
operating activities, which consists primarily of receipt of base interest on
mortgage loans, for the three months ended March 31, 1996 was adequate to
support operating, investing and financing requirements and the payment of
declared distributions to BAC Holders and the General Partner. The Partnership
estimates that future cash flows from receipt of base interest on mortgage
loans, in the aggregate, will be sufficient to pay operating expenses and make
distributions to BAC Holders and the General Partner.
Results of Operations
---------------------
SERIES I
--------
The Partnership's Series I net income for the three months ended March 31,
1996 decreased approximately $23,000 or 3% from the corresponding period in 1995
primarily due to merger-related expenses incurred in the first quarter of 1996
of approximately $76,000. Partially offsetting the decrease in net income was
an increase in interest from mortgage revenue bonds of approximately $38,000
resulting principally from an increase in rental rates at all of the underlying
properties. There were no material increases or decreases in Series I's
remaining income or expenses.
-38-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
The restatement of the 1995 financial statements resulted in increases of
$417,326 and $0.18 in the previously reported net income and net income per BAC
amounts, respectively, for the first quarter of 1995. Net income per BAC as
previously reported for the three months ended March 31, 1995 was $0.14.
Presented below is a summary of base interest payments for the three months
ended March 31, 1996 and 1995 that are due to Series I from the borrowers:
-39-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
<TABLE>
<CAPTION>
For the three months ended March 31, 1996
---------------------------------------------------------------
Base Interest Cumulative
Paid From Current Base Unpaid
Current Base Properties' Interest Full Base
Interest Due(1) Operations Not Paid Interest
--------------- ------------- ------------ -----------
<S> <C> <C> <C> <C>
Observatory II $ 32,000 $ 32,000 $ -- $ --
Royal Oaks 267,324 239,962 27,362 1,620,606
Trailway Pond 115,122 59,856 55,266 907,738
Valley Creek 331,588 252,078 79,510 2,830,691
White Bear Woods 327,731 247,206 80,525 2,081,276
----------- ----------- ---------- -----------
$ 1,073,765 $ 831,102 $ 242,663 $ 7,440,311
=========== =========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
For the three months ended March 31, 1995
---------------------------------------------------------------
Base Interest Cumulative
Paid From Current Base Unpaid
Current Base Properties' Interest Full Base
Interest Due(1) Operations Not Paid Interest
--------------- ------------- ------------ -----------
<S> <C> <C> <C> <C>
Observatory II $ 32,000 $ 32,000 $ -- $ --
Royal Oaks 267,324 213,415 53,909 1,416,382
Trailway Pond 115,122 63,194 51,928 688,760
Valley Creek 331,588 237,721 93,867 2,463,174
White Bear Woods 327,731 246,866 80,865 1,718,622
----------- ----------- ---------- -----------
$ 1,073,765 $ 793,196 $ 280,569 $ 6,286,938
=========== =========== ========== ===========
</TABLE>
(1) The Partnership charges the borrowers interest on unpaid base
interest, which totalled $225,483 and $176,696 for the three months
ended March 31, 1996 and 1995, respectively.
SERIES II
---------
The Partnership's Series II net income for the three months ended March 31,
1996 increased approximately $166,000 or 17% from the corresponding period in
1995 primarily due to an increase in interest from mortgage revenue bonds of
approximately $219,000 resulting principally from the release of $140,500 in
excess tax and insurance reserves relating to three of the underlying
properties. Contributing to the increase in interest from mortgage revenue
bonds was an increase in rental rates and occupancy at all of the underlying
properties. Partially offsetting the increase in net income were merger-related
expenses incurred in the first quarter of 1996 of approximately $76,000. There
-40-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
were no material increases or decreases in Series II's remaining income or
expenses.
The restatement of the 1995 financial statements resulted in increases of
$572,941 and $0.18 in the previously reported net income and net income per BAC
amounts, respectively, for the first quarter of 1995. Net income per BAC as
previously reported for the three months ended March 31, 1995 was $0.13.
Presented below is a summary of base interest payments for the three months
ended March 31, 1996 and 1995 that are due to Series II from the borrowers:
-41-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------
<TABLE>
<CAPTION>
For the three months ended March 31, 1996
---------------------------------------------------------------
Base Interest Cumulative
Paid From Current Base Unpaid
Current Base Properties' Interest Full Base
Interest Due(1) Operations(2) Not Paid Interest
--------------- ------------- ------------ -----------
<S> <C> <C> <C> <C>
Ethan's Ridge and
Ethan's Glen IIB $ 379,688 $ 452,083 $ -- $ 1,929,798
Fountain Place 496,375 440,262 56,113 5,119,611
James Street
Crossing 333,939 224,664 109,275 1,804,446
Trailway Pond II 250,750 152,054 98,696 2,667,402
----------- ----------- ---------- -----------
$ 1,460,752 $ 1,269,063 $ 264,084 $11,521,257
=========== =========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
For the three months ended March 31, 1995
---------------------------------------------------------------
Base Interest Cumulative
Paid From Current Base Unpaid
Current Base Properties' Interest Full Base
Interest Due(1) Operations Not Paid Interest
--------------- ------------- ------------- -----------
<S> <C> <C> <C> <C>
Ethan's Ridge and
Ethan's Glen IIB $ 379,688 $ 310,916 $ 68,772 $ 1,767,296
Fountain Place 496,375 330,846 165,529 4,659,896
James Street
Crossing 333,939 261,980 71,959 1,501,688
Trailway Pond II 250,750 146,766 103,984 2,244,860
----------- ----------- ----------- -----------
$ 1,460,752 $ 1,050,508 $ 410,244 $10,173,740
=========== =========== =========== ===========
</TABLE>
(1) The Partnership charges the borrowers interest on unpaid base interest,
which totalled $336,025 and $274,821 for the three months ended March 31,
1996 and 1995, respectively.
(2) Includes amounts received by the Partnership in January 1996 from the
release of excess tax and insurance reserves relating to 1995. Such
amounts received from Ethan's Ridge and Ethan's Glen IIB, Fountain Place
and James Street Crossing totalled $107,000, $25,700 and $7,800,
respectively.
-42-
<PAGE>
PART II. OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS
-----------------
On September 22, 1995, Irving Zakin commenced a putative class action (the
Zakin Action) against the Partnership, its general partner (CRITEF Associates
Limited Partnership), its Assignor Limited Partner (CRITEF, Inc.), CRI, William
B. Dockser, H. William Willoughby, Capital Realty Investors Tax Exempt Fund III
Limited Partnership, CRITEF III Associates Limited Partnership, CRITEF III,
Inc., and CAPREIT (collectively, the Defendants) in the court of Chancery of the
State of Delaware in New Castle County (the Chancery Court) (C.A. No. 14558).
The complaint alleges, among other things, that the amount offered to the BAC
Holders in the proposed merger at the time the complaint was filed was
inadequate, and that the Defendants breached their fiduciary duty to the BAC
Holders, or aided and abetted such a breach, engaged in self-dealing and misled
BAC Holders, in connection with the proposed merger. The suit seeks to enjoin
the proposed merger, to obtain damages in an unspecified amount for the BAC
Holders, and to compel the Defendants to maximize the amount paid to the BAC
Holders and consider unspecified alternatives to the proposed merger.
On October 5, 1995, David and Johanna Wingard (the Wingard Action)
commenced a second putative class action against the Defendants in the Chancery
Court (C.A. No 14604). The complaint in the Wingard Action contains virtually
the identical allegations and seeks virtually the identical relief as in the
Zakin Action. A request to the Court has been made by the plaintiffs in both
lawsuits to consolidate the two actions.
On January 31, 1996, the Defendants and the plaintiffs and their respective
attorneys reached a tentative settlement of the purported class actions which is
memorialized in a Memorandum of Understanding (the Memorandum), dated as of such
date. The proposed settlement must be approved by the Chancery Court. The
Memorandum contemplates the complete discharge, settlement and release of all
claims that have been, could have been, or in the future might be asserted in
any action or any other proceeding in connection with the proposed merger. The
parties to the Memorandum will use their best efforts to execute an appropriate
Stipulation of Settlement (the Stipulation) and such other documents as may be
required in order to obtain approval by the Chancery Court of the settlement.
The Defendants have denied, and continue to deny, that any of them have
committed or threatened to commit any violations of law or breaches of duty to
the BAC Holders. The Defendants have entered into the Memorandum solely because
the proposed settlement would eliminate the burden and expense of further
litigation and would facilitate the consummation of the proposed merger, which
the General Partner believes to be in the best interest of the BAC Holders.
In accordance with the Memorandum, the agreements for the proposed merger
were amended to provide for the revised merger terms, as previously discussed
above. Pursuant to the Memorandum, the plaintiffs' counsel will be entitled to
apply to the Court for an award of reasonable attorneys' fees and expenses.
Such expenses are not expected to exceed $0.16 and $0.20 per BAC for Series I
and Series II, respectively. These fees will reduce the redemption amounts to
BAC Holders in connection with the proposed merger, as discussed. In the event
that the proposed merger is not consummated, these fees will not be borne by the
Partnership. As such, the Partnership's financial statements do not include any
adjustment for these fees.
Counsel for the plaintiffs have reviewed certain documents relating to the
proposed mergers, and will have the opportunity to review and take depositions
of representatives of the General Partner and CAPREIT. After such review,
counsel for the plaintiffs shall have the right to terminate the settlement
contemplated in the Memorandum, based on material information not presently
available to them.
-43-
<PAGE>
PART II. OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS - Continued
-----------------
After the Stipulation is executed, the parties will seek preliminary
approval of the settlement by the Chancery Court and will then mail notice of
the proposed settlement to members of the putative class. As soon as
practicable following completion of the discovery described in the preceding
paragraph and after class members have had a period of time to review the notice
of proposed settlement, the parties will use their best efforts to obtain final
Chancery Court approval of the settlement and the dismissal of the class actions
as to all of the claims.
On November 9, 1995, CRI filed a complaint against Capital Management
Strategies, Inc. (CMS), a company controlled by Martin C. Schwartzberg, to
determine the proper amount of fees to be paid in 1996 under an asset management
agreement. CMS answered on January 10, 1996, but asserted no counterclaims.
Thereafter, Mr. Schwartzberg launched a hostile consent solicitation to be
designated as managing general partner of approximately 125 private partnerships
sponsored by CRI. Mr. Schwartzberg is a former shareholder and executive
officer of CRI who decided to leave the company as of January 1, 1990. In
connection with his departure, he relinquished his general partner duties for
all CRI-sponsored partnerships, including those of the General Partner. On
March 28, 1996, Mr. Schwartzberg filed a preliminary proxy statement with the
SEC opposing the proposed merger.
On January 18, 1996, Mr. Schwartzberg and CMS filed a complaint in the
Circuit Court of Montgomery County, Maryland (the Circuit Court), against CRI
and Messrs. Dockser and Willoughby alleging, among other things, (i) that CRI
and Messrs. Dockser and Willoughby have breached an asset management agreement
pursuant to which Mr. Schwartzberg's company, CMS, agreed to perform limited
functions related to property-level issues for a portion of CRI's subsidized
housing portfolio (but not properties securing the mortgage revenue bonds) by
reducing the proposed budget for 1996, (ii) that the actions of CRI and Messrs.
Dockser and Willoughby in connection with the proposed merger involve self-
dealing and constitute a breach of their fiduciary duties to Mr. Schwartzberg,
and (iii) that the actions in connection with the merger of CRIIMI MAE Inc. in
June, 1995 involved self-interest and led in part to the proposed reduction of
the asset management agreement budget. Neither of the Partnership nor the
General Partner was named as a defendant in this action, and Mr. Schwartzberg
does not allege that he is a BAC Holder. Messrs. Dockser and Willoughby have
entered an answer denying all of Mr. Schwartzberg's claims and moving to strike
the allegations concerning the Partnership and CRIIMI MAE Inc. and dismiss the
related counts for failure to state a claim upon which relief can be granted.
Messrs. Dockser and Willoughby have publicly responded that Mr. Schwartzberg's
suit is motivated by his budget dispute with CRI and personal animosity.
On February 12, 1996, the Montgomery County Circuit Court issued a
memorandum opinion and order enjoining CMS and Mr. Schwartzberg from disclosing
information made confidential under the asset management agreement.
On February 15, 1996, Mr. Schwartzberg filed suit in the Chancery Court
against the General Partner and CRITEF III Associates Limited Partnership (No.
14837). He alleges that he has made demands upon the General Partner and CRITEF
III Associates Limited Partnership, in his capacity as a general and limited
partner of the General Partner and as a limited partner of CRITEF III Associates
Limited Partnership, to inspect and obtain copies of a current list of the BAC
holders and other documents. He further alleges that his demands were rejected.
On February 23, 1996, the General Partner and CRITEF III Associates Limited
Partnership answered the complaint, admitting that his demands have been
-44-
<PAGE>
PART II. OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS - Continued
-----------------
rejected and denying that Mr. Schwartzberg is entitled to the materials
requested because, among other things, he lacks standing and proper purpose to
inspect and obtain copies of the requested materials. A hearing was held on
March 6 and 7, 1996 and it is expected that the Chancery Court will render a
decision following submission of briefs by the parties.
On February 16, 1996, the Partnership, together with the General Partner,
Capital Realty Investors Tax Exempt Fund III Limited Partnership and its general
partner, CRI, and CAPREIT (collectively, the Plaintiffs) filed suit against Mr.
Schwartzberg in the United States District Court for the Southern District of
New York (the District Court), No. 96 Civ. 1186 (LAK) (the New York Action).
The complaint alleges that Mr. Schwartzberg is engaged in an unlawful
solicitation of proxies of the BAC Holders through two press releases he issued
in violation of the federal securities laws and rules promulgated by the SEC
requiring definitive proxy materials to be filed with the SEC and delivered to
the BAC Holders. The complaint also alleges that Mr. Schwartzberg has made
false and misleading statements in the solicitations concerning the terms of the
proposed merger and the availability of certain financial information, and has
falsely imputed base motives to the principals of the General Partner. On
February 23, 1996, the District Court, without making a finding of fact, issued
a temporary restraining order barring Mr. Schwartzberg from making any
solicitation of the BAC Holders without first complying with the SEC rules
pending a hearing on a proposed preliminary injunction. The District Court held
a hearing on March 5, 1996, on the motion of preliminary injunction, and,
pending a decision, continued the temporary restraining order.
On March 18, 1996, the District Court issued its Opinion enjoining Mr.
Schwartzberg from (1) making any further solicitation of BAC Holders without
complying with the provisions of Regulation 14A under the Securities Exchange
Act of 1934, and (2) committing any violation of Rule 14a-9 (regarding false or
misleading statements) in connection with any solicitation relating to the
Partnerships. The injunction was based on the District Court's findings of fact
and conclusions of law, in which it stated that the Plaintiffs (including the
Partnership) have established a strong likelihood of success on their claim that
the press releases constitute a proxy solicitation in violation of securities
laws and that the Plaintiffs are likely to establish that Mr. Schwartzberg acted
with the requisite culpability with respect to at least some of the false
statements made in his press releases. Also on March 18, 1996, Mr. Schwartzberg
filed his answer to the complaint in the New York action, coupled with
counterclaims against the General Partner alleging that three press releases
issued by the General Partner of the Partnership constituted solicitations in
violation of the same provisions of the Securities Exchange Act and that they
were false and misleading. The counter-defendants deny the allegations. The
counterclaims sought a temporary restraining order against the General Partners
regarding further alleged solicitations and false and misleading statements.
The District Court denied the injunction request by order on April 23, 1996. On
April 16, 1996, Mr. Schwartzberg also filed a Notice of Appeal with respect to
the injunction against him with the U. S. Court of Appeals for the Second
Circuit.
The Partnership Agreement provides for the indemnification of the General
Partners and its affiliates for acts or omissions by the General Partner in good
faith and in the best interest of the Partnership. Such indemnification does
not extend to a finding of liability for conduct which constitutes fraud, bad
faith, misconduct, breach of fiduciary duties, or violation of state or federal
securities laws. At this time, there is no estimate as to the timing or amount,
if any, of the outcome of the New York Action, but the General Partners do not
-45-
<PAGE>
PART II. OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS - Continued
-----------------
anticipate that the litigation will have a material adverse affect on the
Partnership.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
A report on Form 8-K was filed with the Commission on February 8, 1996
regarding improved terms of a cash merger offer from an affiliate of CAPREIT for
redemption of the Partnership's BACs, subject to BAC Holder approval, as well
as an agreement in principle to settle two purported class action suits.
A report on Form 8-K was filed with the Commission on March 22, 1996
regarding the Partnership's filing of preliminary proxy materials with the
Commission regarding the previously announced proposed merger.
All other items are not applicable.
-46-
<PAGE>
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Capital Realty Investors Tax Exempt
Fund Limited Partnership
By: CRITEF Associates Limited
Partnership
General Partner
By: C.R.I., Inc.
General Partner
May 17, 1996 By: /s/ Richard J. Palmer
- -------------------- -----------------------------
Date Richard J. Palmer
Senior Vice President/Finance
Signing on behalf of the Registrant
and as Principal Accounting Officer
-47-
<PAGE>
EXHIBIT INDEX
-------------
Exhibit Method of Filing
- ------- -----------------------------
27 Financial Data Schedule Filed herewith electronically
-48-
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FIRST QUARTER 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 453,646
<SECURITIES> 1,699,852
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 32,909,699
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 32,048,527
<TOTAL-LIABILITY-AND-EQUITY> 32,909,699
<SALES> 0
<TOTAL-REVENUES> 852,948
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 132,593
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 720,355
<INCOME-TAX> 0
<INCOME-CONTINUING> 720,355
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 720,355
<EPS-PRIMARY> 0.31
<EPS-DILUTED> 0.31
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FIRST QUARTER 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 125,544
<SECURITIES> 3,202,926
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 47,147,060
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 45,963,738
<TOTAL-LIABILITY-AND-EQUITY> 47,147,060
<SALES> 0
<TOTAL-REVENUES> 1,310,096
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 145,524
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,164,572
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,164,572
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,164,572
<EPS-PRIMARY> 0.36
<EPS-DILUTED> 0.36
</TABLE>
