KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS, Continued
5. Related Party Transactions
The Trust received $86,609 of Additional Loan Interest during the three months
ended June 30, 2000 from an affiliate of the Advisor. The Trust also received
participation interest $68,762 from an affiliate of the Advisor during the three
months ended June 30, 2000.
The Trust received $86,609 and $86,935 of Additional Loan Interest during the
six months ended June 30, 2001 and 2000, respectively from affiliates of the
Advisor. The Trust also received participation interest of $50,750 and $68,762
from an affiliate of the Advisor during the six months ended June 30, 2001 and
2000, respectively.
6. Subsequent Event
On July 23, 2001, the Trust received a prepayment of The Seasons Subordinated
Promissory Note and the Seasons Additional Loan Note. The Trust received
$1,924,649 of the Additional Loan principal, $238,656 of surplus cash, $847,450
of unpaid preferred interest, $1,052,455 of unpaid contingent interest, $11,390
of unpaid Base Interest on Additional Loans and $1,299,562 which represents its
portion of the residual split. The Trust received $8,567,890 representing the
principal proceeds on the first mortgage note on July 26, 2001. The Advisor
expects to pay a special dividend of $0.93 per share during the third quarter
from the proceeds of the Seasons PIMI prepayment.
The payoff of the Seasons PIMI was a result of a sale of the underlying property
by the borrower, Maryland Associates Limited Partnership (“MALP”),
which is an affiliate of the Adviser, to an affiliate of MALP’s general
partner. Because the sale of the underlying property was to an affiliate, the
Independent Trustees of the Trust were required to approve the transaction,
which they did based upon a number of factors, including an appraisal of the
underlying property prepared by an independent third party MAI appraiser. The
purchase price paid by the affiliate for the underlying property was $1.6
million greater than the value indicated by such appraisal.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONSCertain statements in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this quarterly report on Form 10-Q constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the Trust’s actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. These factors include, among other things, federal, state or local regulations; adverse changes in general economic or local conditions; the inability of the borrower to meet financial obligations on additional loans; pre-payments of mortgages; failure of borrowers to pay participation interests due to poor operating results at properties underlying the mortgages; uninsured losses and potential conflicts of interest between the Trust and its Affiliates, including the Advisor.
Liquidity and Capital ResourcesAt June 30, 2001, the Trust had liquidity consisting of cash and cash equivalents, of approximately $6.2 million as well as the cash inflows provided by PIMs, PIMIs, MBS, cash and cash equivalents. The Trust may also receive additional cash flow from the participation features of its PIMs and PIMIs. The Trust anticipates that these sources will be adequate to provide the Trust with sufficient liquidity to meet its obligations, including providing dividends to its investors.
The most significant demand on the Trust’s liquidity is quarterly dividends, paid to investors of approximately $2.6 million, and special dividends. Funds for dividends come from interest income received on PIMs, PIMIs, MBS, cash and cash equivalents net of operating expenses and the principal collections received on PIMs, PIMIs and MBS. The portion of dividends funded from principal collections reduces the capital resources of the Trust. As the capital resources of the Trust decrease, the total cash flows to the Trust will also decrease which may result in periodic adjustments to the dividends paid to the investors.
The Advisor periodically reviews the dividend rate to determine whether an adjustment is necessary based on projected future cash flows. The current dividend rate is $.17 per Share per quarter. The Trustees, based on the Advisor’s recommendations, generally set a dividend rate that provides for level quarterly dividends. To the extent quarterly dividends do not fully utilize the cash available for distribution and cash balances increase, the Advisor may adjust the dividend rate or distribute such funds through a special dividend.
The Trust’s PIMIs funded the construction or significant rehabilitation of multifamily housing, which requires time to achieve stabilized operations following the completion of the work. With this in mind, the Trust required those borrowers to escrow a portion of the Additional Loan proceeds in reserves so funds would be available for the PIMI Additional Loan payments during the construction and lease-up periods. As these reserves become depleted, full payment of the Additional Loan interest becomes primarily dependent on whether the underlying property generates sufficient operating cash flow to make such payments.
In addition to providing guaranteed or insured monthly principal and interest payments, the Trust’s investments in PIMs and PIMIs also may provide additional income through the interest on the Additional Loan portion of the PIMIs as well as participation income based on operating cash flow and an increase in the value realized upon the sale or refinance of the underlying properties. However, these payments are neither guaranteed nor insured and depend upon the successful operations of the underlying properties.
On July 23, 2001, the Trust received a prepayment of the Seasons Subordinated Promissory Note and the Seasons Additional Loan Note. The Trust received $1,924,649 of the Additional Loan principal, $238,656 of surplus cash, $847,450 of unpaid preferred interest, $1,052,455 of unpaid contingent interest, $11,390 of unpaid Base Interest on Additional Loan and $1,299,562 which represents its portion of the residual split. The Trust received $8,567,890 representing the principal proceeds on the first mortgage note on July 26, 2001. The Advisor expects to pay a special dividend of $0.93 per share during the third quarter from the proceeds of the Seasons PIMI prepayment.
The Trust received the first installment of Additional Loan interest due in 2001 from two of its PIMI investments, Red Run and The Seasons. Two other PIMI investments, Mountain View and Windward Lakes operate under workout agreements with the Trust that require Additional Loan interest payments only if Surplus Cash, as defined by HUD, is generated through property operations. Neither of these properties generated Surplus Cash for the year ended December 31, 2000; consequently, the Trust did not receive any Additional Loan interest.
The Trust received participation interest based on cash flow generated by property operations from four of its investments during the first half of 2001. Waterford Townhomes, paid $60,502, Red Run paid $21,630, The Seasons paid $50,750 and Lifestyles paid $118,968.
Three properties operate under workout agreements with the Trust. Windward Lakes’ operating results deteriorated during 1995 and 1996, and in early 1997 the independent Trustees approved a workout with the borrower of the Windward Lakes PIMI, an affiliate of the Advisor of the Trust. In the workout, the Trust agreed to reduce the effective basic interest rate on the insured first mortgage by 2% per annum for 1997 and 1% per annum for 1998, 1999 and 2000. The borrower made an equity contribution of $133,036 to the property and agreed to cap the annual management fee paid to an affiliate at 3% of revenues. The Trust’s participation in current operations is 50% of any Surplus Cash as determined under HUD guidelines, and the Additional Loan interest is payable out of its share of Surplus Cash. Any unpaid Additional Loan interest accrues at 7.5% per annum. When the property is sold or refinanced, the Trust will receive 50% of any net proceeds remaining after repayment of the insured mortgage, the Additional Loan, the interest rate relief, accrued and unpaid Additional Loan interest and the Borrower’s equity up to the point that the Trust has received a cumulative, non-compounded 10% preferred return on its investment in the PIMI.
Lifestyles operating results deteriorated during 1995, and the Trust approved a two-year workout that effectively reduced the interest rate on the insured mortgage by 1%. When that workout ended in 1997, the property was not able to generate sufficient revenues to maintain the property and service the original interest rate. Consequently, the borrower on the Lifestyles PIMI defaulted on its May 1, 1998 debt service payment on the insured first mortgage. The Trust agreed to a new workout that runs through 2007. Under its terms, the Trust agreed to reduce the effective interest rate on the insured first mortgage by 1.75% retroactively for 1998 to clear the default, by 1.75% for 1999, and by 1.5% each year thereafter until the property is sold or refinanced. An affiliate of the Advisor refunds approximately .25% per annum to the Trust related to the interest reduction. The borrower made a $550,000 equity contribution, which has been escrowed, for the exclusive purpose of correcting deferred maintenance and making capital improvements to the property. The escrow has been used up for paint, building repairs, parking lot repairs, a new fitness facility, clubhouse remodeling and landscaping. Any Surplus Cash that is generated by property operations will be split evenly between the Trust and the borrower. When the property is sold or refinanced, the first $1,100,000 of any proceeds remaining after the insured mortgage is paid off will be split 50% / 50% between the Trust and the borrower; the next $1,690,220 of proceeds will be split 75% to the Trust and 25% to the borrower; and any remaining proceeds will be split 50% / 50%. The borrower’s new equity and the reduction in the effective interest rate on the insured first mortgage will provide funds for repairs and improvements that should help reposition Lifestyles so it can compete more effectively for new residents and rental rates. As a result of the factors described above, the Trust determined that the Additional Loan collateralized by the Lifestyles asset was impaired, and recorded a valuation allowance of $1,130,346 in the fourth quarter of 1998 and continues to maintain that allowance.
Mountain View has experienced problems similar to Lifestyles with respect to competitive market conditions. In June 1999, the Trust approved a second workout that runs through 2004. Under its terms, the Trust agreed to reduce the effective interest rate on the insured first mortgage by 1.25% retroactively for 1999 and each year thereafter until the property is sold or refinanced, and to change the participation terms. The workout eliminated the preferred return feature, forgave $288,580 of previous accruals of Additional Loan interest related to the first workout, and changed the Trust’s participation in Surplus Cash generated by the property. The Trust will receive 75% of the first $130,667 of Surplus Cash and 50% of any remaining Surplus Cash on an annual basis to pay Additional Loan interest. Unpaid Additional Loan interest related to the second workout will accrue and be payable if there are sufficient proceeds from a sale or refinancing of the property. In addition, the borrower repaid $153,600 of the Additional Loan and funded approximately $54,000 to a reserve for property improvements. As a result of the factors described above, the Advisor determined that the Additional Loan collateralized by the Mountain View asset was impaired and has recorded a valuation allowance of $1,032,272 and continues to maintain that allowance.
Whether the operating performance at any of the properties mentioned above provide sufficient cash flow from operations to pay either the Additional Loan interest or participation income will depend on factors over which the Trust has little or no control over. Should the properties be unable to generate sufficient cash flow to pay the Additional Loan interest, it would reduce the Trust’s distributable cash flow and could affect the value of the Additional Loan collateral.
There are contractual restrictions on the repayment of the PIMs and PIMIs. During the first five years of the investment, borrowers are prohibited from repayment. During the second five years, the PIM borrowers can prepay the insured first mortgage by paying the greater of a prepayment premium or the participation due at the time of the prepayment. Similarly, the PIMI borrowers can prepay the insured first mortgage and the Additional Loan by satisfying the Preferred Return obligation. The participation features and Additional Loans are neither insured nor guaranteed. If the prepayment of the PIM or PIMI results from the foreclosure on the underlying property or an insurance claim, the Trust would probably not receive any participation income or any amounts due under the Additional Loan.
The Trust has the option to call certain PIMs and all the PIMIs by accelerating their maturity if the loans are not prepaid by the tenth year after permanent funding. The Advisor will determine the merits of exercising the call option for each PIM and PIMI as economic conditions warrant. Such factors as the condition of the asset, local market conditions, the interest rate environment and available financing will have an impact on these decisions.
Results of OperationsNet income of the Trust increased for the three and six months ended June 30, 2001 as compared to the same periods in 2000 due to increases in interest income on PIMs and PIMIs. This is partially offset by a decrease in the MBS interest income. Additional loan interest increased due to an increase in the 2001 amortization of deferred income on the Red Run PIMI. Basic interest on PIMs and PIMIs increased due to the expiration of the interest rate reduction for the Windward Lakes PIMI on December 31, 2000. Participation interest increased primarily due to the surplus cash received from the Lifestyles PIMI. MBS interest income decreased due to principal payments reducing the asset base.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Assessment of Credit Risk
The Trust’s investments in insured mortgages and MBS are guaranteed or insured by Fannie Mae, the Federal Home Loan Mortgage Corporation (FHLMC), the Government National Mortgage Association (GNMA) and the Department of Housing and Urban Development (HUD) and therefore the certainty of their cash flows and the risk of material loss of the amounts invested depends on the creditworthiness of these entities.
Fannie Mae is a federally chartered private corporation that guarantees obligations originated under its programs. FHLMC is a federally chartered corporation that guarantees obligations originated under its programs and is wholly-owned by the twelve Federal Home Loan Banks. These obligations are not guaranteed by the U.S. Government or the Federal Home Loan Bank Board. GNMA guarantees the full and timely payment of principal and basic interest on the securities it issues, which represents interest in pooled mortgages insured by HUD. Obligations insured by HUD, an agency of the U.S. Government, are backed by the full faith and credit of the U.S. Government.
The Trust’s Additional Loans have similar risks as those associated with higher risk debt instruments, including: reliance on the owner’s operating skills, ability to maintain occupancy levels, control operating expenses, ability to maintain the properties and obtain adequate insurance coverage. Operations also may be effected by adverse changes in general economic conditions, adverse local conditions, and changes in governmental regulations, real estate zoning laws, or tax laws, and other circumstances over which the Trust may have little or no control.
At June 30, 2001 the Trust included in cash and cash equivalents approximately $6.2 million held in a money market fund which invests in securities which are primarily direct obligations of the U.S. Government or securities issued by agencies and instrumentalities of the U.S. Government which may be guaranteed, supported or backed by the credit of the U.S. Government or agencies thereof.
Interest Rate RiskThe Trust’s primary market risk exposure is to interest rate risk, which can be defined as the exposure of the Trust’s net income, comprehensive income or financial condition to adverse movements in interest rates. At June 30, 2001, the Trust’s PIMs, PIMIs and MBS comprise the majority of the Trust’s assets. As such, decreases in interest rates may accelerate the prepayment of the Trust’s investments. The Trust does not utilize any derivatives or other instruments to manage this risk as the Trust plans to hold all of its investments to expected maturity.
The Trust monitors prepayments and considers prepayment trends, as well as distribution requirements of the Trust, when setting regular dividend policy. For MBS, the fund forecasts prepayments based on trends in similar securities as reported by statistical reporting entities such as Bloomberg. For PIMs and PIMIs, the Trust incorporates prepayment assumptions into planning as individual properties notify the Trust of the intent to prepay or as they mature.
KRUPP GOVERNMENT INCOME TRUST
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Response: None
Item 2. Changes in Securities
Response: None
Item 3. Defaults upon Senior Securities
Response: None
Item 4. Submission of Matters to a Vote of Security Holders
Response: None
Item 5. Other Information
Response: None
Item 6. Exhibits and Reports on Form 8-K
Reponse: None
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Krupp Government Income Trust
-----------------------------
(Registrant)
BY: / s / Robert A. Barrows
--------------------------------------------
Robert A. Barrows
Treasurer and Chief Accounting Officer
of Krupp Government Income Trust
DATE: August 3, 2001
Unaudited amounts in thousands, except per Share amounts
Six Months Inception
Ended Through
6/30/01 6/30/01
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Distributable Cash Flow (a):
---------------------------
Net income $ 4,187 $ 137,404
Items not requiring or providing the
use of operating funds:
Provision for impaired mortgage loan - 2,163
Amortization of prepaid fees and
expenses and organization costs 514 16,372
Additional Loan Interest Deferred (184) 3,367
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Total Distributable Cash Flow ("DCF") 4,517 159,306
------------ ------------
DCF per Share based on Shares
outstanding at June 30, 2001 $ 0.30 $ 10.58 (d)
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Dividends:
Total dividends to Shareholders $ 5,118 (b) $ 284,848 (c)
============ ============
Average dividend per Share based
on Shares outstanding at
June 30, 2001 $ 0.34 (b) $ 18.92 (c)(d)
============ ============
(a) Distributable Cash Flow consists of income before provision for
impaired mortgage loans, amortization of prepaid fees and
expenses and organization costs and includes deferred interest
on Additional Loans. The Trust believes Distributable Cash Flow
is an appropriate supplemental measure of operating performance,
however, it should not be considered as a substitute for net
income as an indication of operating performance or cash flows
as a measure of liquidity.
(b) Represents all dividends paid through June 2001 except the
February 2001 dividend and includes an estimate of the
August 2001 dividend.
(c) Includes as estimate of the August 2001 dividend.
(d) Shareholders average per Share return of capital on a cash basis
as of June 2001 is $8.34 [$18.92- $10.58]. Return of capital
represents that portion of the dividends which is not funded
from DCF such as principal collections received from MBS and
PIMs.
