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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-QSB
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
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Commission file number 0-11973
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
Organized pursuant to the Laws of the State of Maryland
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Internal Revenue Service - Employer Identification No. 52-1321492
11200 Rockville Pike, Rockville, Maryland 20852
(301) 468-9200
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Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days. Yes |X| No | |
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CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
INDEX TO FORM 10-QSB
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
Page
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Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets
- September 30, 2003 and December 31, 2002...................... 1
Statements of Operations and Accumulated Losses
- for the three and nine months ended September 30, 2003
and 2002.................................................... 2
Statements of Cash Flows
- for the nine months ended September 30, 2003 and 2002......... 3
Notes to Financial Statements
- September 30, 2003 and 2002................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 10
Item 3. Controls and Procedures........................................... 13
Part II - OTHER INFORMATION
Item 3. Defaults Upon Senior Securities................................... 14
Item 5. Other Information................................................. 14
Item 6. Exhibits and Reports on Form 8-K.................................. 15
Signature.................................................................. 16
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
BALANCE SHEETS
ASSETS
September 30, December 31,
2003 2002
------------ ------------
(Unaudited)
Investments in and advance to partnerships ........................................ $ 899,114 $ 1,360,493
Investment in partnerships held for transfer ...................................... 506,371 7,577
Cash and cash equivalents ......................................................... 4,508,484 3,420,489
Acquisition fees, principally paid to related parties,
net of accumulated amortization of $215,200 and $232,563, respectively .......... 110,258 132,628
Property purchase costs,
net of accumulated amortization of $242,449 and $244,318, respectively .......... 130,213 146,200
Other assets ...................................................................... 67 335,845
------------ ------------
Total assets ................................................................... $ 6,154,507 $ 5,403,232
============ ============
LIABILITIES AND PARTNERS' CAPITAL
Due on investments in partnerships ................................................ $ 1,400,000 $ 1,900,000
Accrued interest payable .......................................................... 2,594,762 2,677,938
Accounts payable and accrued expenses ............................................. 116,025 113,301
------------ ------------
Total liabilities .............................................................. 4,110,787 4,691,239
------------ ------------
Commitments and contingencies
Partners' capital:
Capital paid in:
General Partners .............................................................. 2,000 2,000
Limited Partners .............................................................. 50,015,000 50,015,000
------------ ------------
50,017,000 50,017,000
Less:
Accumulated distributions to partners ......................................... (13,904,726) (13,904,726)
Offering costs ................................................................ (5,278,980) (5,278,980)
Accumulated losses ............................................................ (28,789,574) (30,121,301)
------------ ------------
Total partners' capital ..................................................... 2,043,720 711,993
------------ ------------
Total liabilities and partners' capital ..................................... $ 6,154,507 $ 5,403,232
============ ============
The accompanying notes are an integral part
of these financial statements.
-1-
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
STATEMENTS OF OPERATIONS
AND ACCUMULATED LOSSES
(Unaudited)
For the three months ended For the nine months ended
September 30, September 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Share of income from partnerships ............... $ 221,192 $ 187,753 $ 1,226,805 $ 1,136,937
------------ ------------ ------------ ------------
Other revenue and expenses:
Revenue:
Interest .................................... 6,336 13,685 22,493 36,213
Gain from extinguishment of debt ............ -- -- 670,099 599,123
------------ ------------ ------------ ------------
6,336 13,685 692,592 635,336
------------ ------------ ------------ ------------
Expenses:
Interest .................................... 31,500 57,935 94,500 173,805
Management fee .............................. 62,499 62,499 187,497 187,497
General and administrative .................. 66,520 70,642 207,190 186,895
Professional fees ........................... 23,250 22,250 79,750 66,750
Amortization of deferred costs .............. 6,138 6,532 18,733 20,067
------------ ------------ ------------ ------------
189,907 219,858 587,670 635,014
------------ ------------ ------------ ------------
Total other revenue and expenses .......... (183,571) (206,173) 104,922 322
------------ ------------ ------------ ------------
Income (loss) before gain on disposition of
investment in partnership ..................... 37,621 (18,420) 1,331,727 1,137,259
Gain on disposition of investment in
partnership ................................... -- 2,502,001 -- 2,502,001
------------ ------------ ------------ ------------
Net income ...................................... 37,621 2,483,581 1,331,727 3,639,260
Accumulated losses, beginning of period ......... (28,827,195) (32,895,518) (30,121,301) (34,051,197)
------------ ------------ ------------ ------------
Accumulated losses, end of period ............... $(28,789,574) $(30,411,937) $(28,789,574) $(30,411,937)
============ ============ ============ ============
Net income allocated
to General Partners (1.51%) ................... $ 568 $ 37,502 $ 20,109 $ 54,953
============ ============ ============ ============
Net income allocated
to Initial and Special Limited Partners (1.49%) $ 561 $ 37,005 $ 19,843 $ 54,225
============ ============ ============ ============
Net income allocated
to Additional Limited Partners (97%) .......... $ 36,492 $ 2,409,074 $ 1,291,775 $ 3,530,082
============ ============ ============ ============
Net income per unit of Additional Limited Partner
Interest, based on 49,910 units outstanding ... $ 0.73 $ 48.27 $ 25.88 $ 70.73
============ ============ ============ ============
The accompanying notes are an integral part
of these financial statements.
-2-
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
(Unaudited)
For the nine months ended
September 30,
--------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net income .................................................................. $ 1,331,727 $ 3,639,260
Adjustments to reconcile net income to net cash used in operating activities:
Share of income from partnerships ......................................... (1,226,805) (1,136,937)
Gain from extinguishment of debt .......................................... (670,099) (599,123)
Amortization of deferred costs ............................................ 18,733 20,067
Gain on disposition of investment in partnership .......................... -- (2,502,001)
Changes in assets and liabilities:
Increase in advances to partnerships .................................... -- (1,118)
Decrease (increase) in other assets ..................................... 335,778 (146)
Increase in accrued interest payable .................................... 94,500 173,805
Increase in accounts payable and accrued expenses ....................... 2,724 11,038
----------- -----------
Net cash used in operating activities ................................. (113,442) (395,155)
----------- -----------
Cash flows from investing activities:
Receipt of distributions from partnerships .................................. 1,200,394 1,149,175
Proceeds from disposition of investment in partnership, net ................. -- 2,533,725
Additional proceeds from disposition of investment in partnership ........... 1,043 --
----------- -----------
Net cash provided by investing activities ............................. 1,201,437 3,682,900
----------- -----------
Cash flows from financing activities:
Distribution to General Partners and Initial and Special Limited Partners ... -- (199,485)
----------- -----------
Net increase in cash and cash equivalents ..................................... 1,087,995 3,088,260
Cash and cash equivalents, beginning of period ................................ 3,420,489 3,242,912
----------- -----------
Cash and cash equivalents, end of period ...................................... $ 4,508,484 $ 6,331,172
=========== ===========
The accompanying notes are an integral part
of these financial statements.
-3-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 30, 2003 and 2002
(Unaudited)
1. BASIS OF PRESENTATION
In the opinion of C.R.I., Inc. (CRI), the Managing General Partner, the
accompanying unaudited financial statements reflect all adjustments, consisting
of normal recurring accruals, necessary for a fair presentation of the financial
position of Capital Realty Investors-II Limited Partnership (the Partnership) as
of September 30, 2003, and the results of its operations for the three and nine
months ended September 30, 2003 and 2002, and its cash flows for the nine months
ended September 30, 2003 and 2002. The results of operations for the interim
periods ended September 30, 2003, are not necessarily indicative of the results
to be expected for the full year.
The accompanying unaudited financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America and with the instructions to Form 10-QSB. Certain information and
accounting policies and footnote disclosures normally included in financial
statements prepared in conformity with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
instructions. These condensed financial statements should be read in conjunction
with the financial statements and notes thereto included in the Partnership's
annual report on Form 10-KSB at December 31, 2002.
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. FIN
46 clarifies the application of Accounting Research Bulletin 51, Consolidated
Financial Statements, for certain entities that do not have sufficient equity at
risk for the entity to finance its activities without additional subordinated
financial support from other parties or in which equity investors do not have
the characteristics of a controlling financial interest ("variable interest
entities"). Variable interest entities within the scope of FIN 46 will be
required to be consolidated by their primary beneficiary. The primary
beneficiary of a variable interest entity is determined to be the party that
absorbs a majority of the entity's expected losses, receives a majority of its
expected returns, or both. Application of the provisions of FIN 46 has been
deferred until the end of the first interim or annual period ending after
December 15, 2003, to variable interest entities in which an enterprise holds a
variable interest that it acquired before February 1, 2003. The Managing General
Partner is in the process of determining what impact, if any, the adoption of
the provisions of FIN 46 will have upon the Partnership's financial condition
and results of operations related to the Partnership's investments in limited
partnership (Local Partnerships), and has complied with the disclosure
requirements of FIN 46 in these financial statements. As of September 30, 2003,
the Partnership's maximum loss exposure related to its investments in and
advances to partnerships is limited to the remaining balance of $1,405,485.
2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS
a. Due on investments in partnerships and accrued interest payable
---------------------------------------------------------------
Purchase money notes
--------------------
The Partnership's remaining obligation with respect to its investment in
Local Partnerships, in the form of a nonrecourse purchase money note having a
principal balance of $1,400,000 plus accrued interest of $2,594,762 as of
September 30, 2003, matured on September 1, 2003, and was not paid. The purchase
money note, which is nonrecourse to the Partnership, is secured by the
Partnership's interest in the related Local Partnership, Westgate Tower Limited
Dividend Housing Association (Westgate). See below for further discussion of the
Partnership's default on this purchase money note.
-4-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 30, 2003 and 2002
(Unaudited)
2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued
The Partnership's inability to pay the purchase money note principal and
accrued interest balance when due, and the resulting uncertainty regarding the
Partnership's continued ownership interest in Westgate, does not adversely
impact the Partnership's financial condition because the purchase money note is
nonrecourse and secured solely by the Partnership's interest in Westgate.
Therefore, even though the Partnership's investment in Westgate has not produced
sufficient value to satisfy the related purchase money note, the Partnership's
exposure to loss is limited because the amount of the nonrecourse indebtedness
of the maturing purchase money note exceeds the carrying amount of the
investment in Westgate. Thus, even a complete loss of the Partnership's interest
in Westgate would not have a material adverse impact on the financial condition
of the Partnership. In the event of a foreclosure or other transfer of the
Partnership's interest, the excess of the nonrecourse indebtedness over the
carrying amount of the Partnership's investment in Westgate will result in
taxable gain. This gain will be taxable to Limited Partners at a federal tax
rate of up to 25%, as it will reflect recapture of depreciation deductions
claimed in prior years. Additionally, in the event of a foreclosure or other
transfer of the Partnership's interest, the Partnership would lose its
investment in Westgate and, likewise, its share of any future cash flow
distributed by Westgate from rental operations, mortgage debt refinancings, or
the sale of the real estate.
Interest expense on the Partnership's purchase money notes for the three
and nine month periods ended September 30, 2003, was $31,500 and $94,500,
respectively, and $57,935 and $173,805 for the three and nine month periods
ended September 30, 2002, respectively. The accrued interest payable on the
purchase money notes of $2,594,762 and $2,677,938 as of September 30, 2003, and
December 31, 2002, respectively, is due on the respective maturity dates of the
purchase money notes or earlier, in some instances, if (and to the extent of a
portion thereof) the related Local Partnership has distributable net cash flow,
as defined in the relevant Local Partnership agreement.
Princeton
---------
The Partnership defaulted on its purchase money note related to Princeton
Community Village Associates (Princeton) on January 1, 1999, when the note
matured and was not paid. The default amount included principal and accrued
interest of $500,000 and $1,422,064, respectively. On August 9, 1999, the
noteholder filed a complaint seeking declaratory judgment that the Partnership
had forfeited its interest in Princeton to the noteholder. The litigation was
settled effective January 1, 2000, when the Managing General Partner entered
into an agreement with the noteholder which granted the noteholder four options
to purchase the Partnership's 98.99% limited partner interest in Princeton over
a three and one-half year period, in exchange for the cancellation of pro-rata
portions of the then outstanding balance of the purchase money note. As part of
the agreement, the noteholder extended the maturity date of the purchase money
note to January 1, 2004, and the Partnership made a payment to the noteholder on
April 21, 2000, which was applied against accrued interest payable on the
purchase money note. However, pursuant to the option agreement with the
noteholder, the noteholder could exercise its option to acquire the final
portion of the Partnership's interest between January 1, 2003, and June 30,
2003.
-5-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 30, 2003 and 2002
(Unaudited)
2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued
On January 1, 2003, pursuant to the option agreement, the noteholder
purchased the Partnership's remaining limited partner interest in Princeton, the
consideration for which was the cancellation of the remaining $677,676 of
purchase money note principal and accrued interest. The purchase resulted in
gain on extinguishment of debt of $670,099 for financial statement purposes and
a total gain of $1,854,098 for federal tax purposes in 2003. On April 30, 2002,
pursuant to the option agreement, the noteholder purchased one-half of the
Partnership's then- remaining limited partner interest in Princeton, the
consideration for which was the cancellation of $606,700 of purchase money note
accrued interest. The purchase resulted in gain on extinguishment of debt of
$599,123 for financial statement purposes and a total gain of $1,783,122 for
federal tax purposes in 2002. On both June 1, 2001, and May 31, 2000, pursuant
to the option agreement, the noteholder purchased 26% of the Partnership's
original limited partner interest in Princeton, the consideration for which was
the cancellation of a like percentage of the then-outstanding purchase money
note accrued interest of $392,333 and $493,027, respectively, resulting in gain
from extinguishment of debt of $384,123 and $484,862 for financial statement
purposes in 2001 and 2000, respectively, and in a total gain of $1,583,512 and
$1,921,910 for federal tax purposes in 2001 and 2000, respectively.
Due to the subsequent transfer of the Partnership's remaining interest in
Princeton, the Partnership's basis in the Local Partnership, along with the net
unamortized acquisition fees and property purchase costs, which totaled $7,577
as of December 31, 2002, was reclassified to investment in partnerships held for
transfer in the accompanying balance sheet at that date.
Westgate
--------
The Partnership defaulted on its purchase money note related to Westgate on
September 1, 2003, when the note (as extended) matured and was not paid. The
default amount included principal and accrued interest of $1,400,000 and
$2,584,492, respectively. As of November 4, 2003, principal and accrued interest
of $1,400,000 and $2,606,585, respectively, were due. In September 2003, the
Managing General Partner offered to tender the Partnership's interest in
Westgate to the purchase money noteholders, in full satisfaction of the
principal and accrued interest balances due on the purchase money note. As of
November 4, 2003, the trustee for the noteholders acknowledged receipt of the
Managing General Partner's offer, but indicated that it would need several
months to formulate a recommendation to, and obtain a response from, the
beneficial noteholders. There is no assurance that the noteholders will accept
the offer, or what other course of action the noteholders might choose to
pursue.
Due to the possible transfer of the Partnership's interest in Westgate to
the noteholders, the Partnership's basis in the Local Partnership, along with
the net unamortized acquisition fees and property purchase costs, which totaled
$506,371 as of September 30, 2003, has been reclassified to investment in
partnerships held for transfer in the accompanying balance sheet at that date.
b. Summarized financial information
--------------------------------
Combined statements of operations for the 12 and 13 Local Partnerships in
which the Partnership was invested as of September 30, 2003 and 2002,
respectively, follow. The combined statements have been compiled from
information supplied by the management agents of the projects and are unaudited.
The information for each of the periods is presented separately for those Local
Partnerships which have investment basis (equity method), and for those Local
Partnerships for which the Partnership's carrying value is zero (equity method
suspended). Appended after the combined statements is information concerning the
Partnership's share of income from partnerships related to cash distributions
recorded as income, and related to the Partnership's share of income from Local
Partnerships.
-6-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 30, 2003 and 2002
(Unaudited)
2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued
COMBINED STATEMENTS OF OPERATIONS
(Unaudited)
For the three months ended
September 30,
-----------------------------------------------------------
2003 2002
------------------------- --------------------------
Equity Equity
Method Suspended Method Suspended
---------- ---------- ---------- ----------
Number of Local Partnerships 3 9 4 9
= = = =
Revenue:
Rental $1,083,911 $2,850,338 $ 937,773 $3,820,295
Other 59,583 121,932 34,549 256,603
---------- ---------- ---------- ----------
Total revenue 1,143,494 2,972,270 972,322 4,076,898
---------- ---------- ---------- ----------
Expenses:
Operating 579,254 1,686,930 543,540 2,331,861
Interest 133,309 1,024,994 101,116 1,166,628
Depreciation and amortization 151,667 487,845 131,280 687,734
---------- ---------- ---------- ----------
Total expenses 864,230 3,199,769 775,936 4,186,223
---------- ---------- ---------- ----------
Net income (loss) $ 279,264 $ (227,499) $ 196,386 $ (109,325)
========== ========== ========== ==========
Cash distributions $ 199,980 $ 57,979 $ -- $ 69,839
========== ========== ========== ==========
Cash distributions recorded
as reduction of investments
in partnerships $ 199,980 $ -- $ -- $ 53,582
========== ========== ========== ==========
Cash distributions recorded
as income $ -- $ 57,979 $ -- $ 16,257
Partnership's additional share of
Local Partnership net income 163,213 -- 117,914 53,582 (1)
Miscellaneous -- -- -- --
-------------------------- -------------------------
Share of income from partnerships $221,19 $187,753
======= ========
(1) Represents Partnership's share of income from a Local Partnership for
which the Partnership's carrying value is zero, but which does not
have unallowable losses.
-7-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 30, 2003 and 2002
(Unaudited)
2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued
For the nine months ended
September 30,
------------------------------------------------------------
2003 2002
-------------------------- --------------------------
Equity Equity
Method Suspended Method Suspended
---------- ---------- ---------- -----------
Number of Local Partnerships 3 9 4 9
= = = =
Revenue:
Rental $3,246,764 $8,546,833 $2,835,059 $11,460,889
Other 111,287 343,075 89,499 769,814
---------- ---------- ---------- -----------
Total revenue 3,358,051 8,889,908 2,924,558 12,230,703
---------- ---------- ---------- -----------
Expenses:
Operating 1,870,421 5,033,362 1,785,237 6,995,586
Interest 399,926 3,074,983 303,348 3,499,882
Depreciation and amortization 455,005 1,463,543 393,840 2,063,206
---------- ---------- ---------- -----------
Total expenses 2,725,352 9,571,888 2,482,425 12,558,674
---------- ---------- ---------- -----------
Net income (loss) $ 632,699 $ (681,980) $ 442,133 $ (327,971)
========== ========== ========== ===========
Cash distributions $ 600,743 $ 599,651 $ 449,028 $ 700,147
========== ========== ========== ===========
Cash distributions recorded
as reduction of investments
in partnerships $ 600,743 $ 273,296 $ 449,028 $ 160,751
========== ========== ========== ===========
Cash distributions recorded
as income $ -- $ 326,355 $ -- $ 539,396
Partnership's share of Local
Partnership net income 630,390 269,017 (1) 437,908 160,751 (1)
Miscellaneous -- 1,043 -- (1,118)
-------------------------- -------------------------
Share of income from partnerships $1,226,805 $1,136,937
========== ==========
(1) Represents Partnership's share of income from a Local Partnership for
which the Partnership's carrying value is zero, but which does not
have unallowable losses.
All of the cash distributions recorded as income are included in share of
income from partnerships on the statements of operations for the respective
periods, and are recorded as cash receipts on the respective balance sheets. As
of September 30, 2003 and 2002, the Partnership's share of cumulative losses to
date for eight of the 12 and 13 Local Partnerships, respectively, exceeded the
amount of the Partnership's investments in and advances to those Local
Partnerships by $19,844,126 and $21,229,715, respectively. As the Partnership
has no further obligation to advance funds or provide financing to these Local
Partnerships, the excess losses have not been reflected in the accompanying
financial statements.
-8-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 30, 2003 and 2002
(Unaudited)
3. RELATED PARTY TRANSACTIONS
In accordance with the terms of the Partnership Agreement, the Partnership
is obligated to reimburse the Managing General Partner for its direct expenses
in connection with managing the Partnership. The Partnership paid $54,397 and
$173,550 for the three and nine month periods ended September 30, 2003,
respectively, and $44,030 and $138,568 for the three and nine month periods
ended September 30, 2002, respectively, to the Managing General Partner as
direct reimbursement of expenses incurred on behalf of the Partnership. Such
expenses are included in the accompanying statements of operations as general
and administrative expenses.
In accordance with the terms of the Partnership Agreement, the Partnership
is obligated to pay the Managing General Partner an annual incentive management
fee (Management Fee) after all other expenses of the Partnership are paid. The
Partnership paid the Managing General Partner a Management Fee of $62,499 for
each of the three month periods ended September 30, 2003 and 2002, and $187,497
for each of the nine month periods ended September 30, 2003 and 2002.
The Managing General Partner and/or its affiliates may receive a fee of not
more than two percent of the sales price of an investment in a Local Partnership
or the property it owns, payable under certain conditions upon the sale of an
investment in a Local Partnership or the property it owns. The payment of the
fee is subject to certain restrictions, including the achievement of a certain
level of sales proceeds and making certain minimum distributions to limited
partners. In September 2002, the Managing General Partner was paid a disposition
fee of $128,000 relating to the sale of Rock Glen, which was netted against the
related gain on disposition of investment in partnership.
# # #
-9-
Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
-------------------------------------------------------
and Results of Operations
-------------------------
Capital Realty Investors-II Limited Partnership's (the Partnership)
Management's Discussion and Analysis of Financial Condition and Results of
Operations section is based on the financial statements, and contains
information that may be considered forward looking, including statements
regarding the effect of governmental regulations. Actual results may differ
materially from those described in the forward looking statements and will be
affected by a variety of factors including national and local economic
conditions, the general level of interest rates, governmental regulations
affecting the Partnership and interpretations of those regulations, the
competitive environment in which the Partnership operates, and the availability
of working capital.
Critical Accounting Policies
----------------------------
The Partnership has disclosed its selection and application of significant
accounting policies in Note 1 of the notes to financial statements included in
the Partnership's annual report on Form 10-KSB at December 31, 2002. The
Partnership accounts for its investments in partnerships (Local Partnerships) by
the equity method because the Partnership is a limited partner in the Local
Partnerships. As such the Partnership has no control over the selection and
application of accounting policies, or the use of estimates, by the Local
Partnerships.
General
-------
Some of the rental properties owned by the Local Partnerships are financed
by state housing agencies. The Managing General Partner has sold or refinanced,
and will continue to sell or refinance, certain properties pursuant to programs
developed by these agencies. These programs may include opportunities to sell a
property to a qualifying purchaser who would agree to maintain the property as
low to moderate income housing, or to refinance a property, or to obtain
supplemental financing. The Managing General Partner continues to monitor
certain state housing agency programs, and/or programs provided by certain
lenders, to ascertain whether the properties would qualify within the parameters
of a given program and whether these programs would provide an appropriate
economic benefit to the Limited Partners of the Partnership.
Some of the rental properties owned by the Local Partnerships are dependent
on the receipt of project-based Section 8 Rental Housing Assistance Payments
(HAP) provided by the U.S. Department of Housing and Urban Development (HUD)
pursuant to Section 8 HAP contracts. Current legislation allows all expired
Section 8 HAP contracts with rents at less than 100% of fair market rents to be
renewed for up to one year. Expiring Section 8 HAP contracts with rents that
exceed 100% of fair market rents could be renewed for up to one year, but at
rents reduced to 100% of fair market rents (Mark-to-Market). All expiring
Section 8 HAP contracts with rents exceeding comparable market rents, and
properties with mortgage loans insured by the Federal Housing Administration
(FHA), became subject to the Mark-to-Market legislation.
Mark-to-Market (M2M) implementation will reduce rental income at properties
that are currently subsidized at higher-than-market rental rates, and will
therefore lower cash flow available to meet mortgage payments and operating
expenses. In some instances, a property will be able to meet its existing debt
service payments after the reduction in rental income. In this case, the
property may enter the M2M "Lite" program, which would not require a debt
restructuring. In the remaining instances, the affected property may undergo
debt restructuring according to terms determined by an individual property and
operations evaluation. This would involve reducing the first mortgage loan
balance to an amount supportable by the property's operations, taking into
account the property's operating expenses and reduced income. The balance of the
amount written down from the first mortgage loan would be converted to a
non-performing but accruing (soft) second mortgage loan. When the existing first
mortgage loan is bifurcated into a first and second mortgage loan, the newly
created second mortgage loan will accrue interest at a below-market rate. The
Internal Revenue Service issued a ruling in July 1998 that concluded that the
below-market rate of interest would not generate additional ordinary income.
Each property subject to M2M will be affected in a different manner, and it is
very difficult to predict the exact form of restructuring, or potential tax
liabilities to the Limited Partners, at this time. All properties, upon entering
the M2M program (excluding M2M Lite), are required to enter into an agreement
restricting the property's use to affordable housing for 30 years.
-10-
Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
-------------------------------------------------------
and Results of Operations - Continued
-------------------------
Finally, under HUD's "Mark-up-to-Market" program, properties with expiring
Section 8 HAP contracts that are located in high-rent areas as defined by HUD
are eligible for rent increases which would be necessary to bring Section 8 HAP
contract rents in line with market rate rents. For properties that enter the
program and have interest rate subsidized FHA loans, the rents are adjusted to
take into account the benefits the property is already receiving from the
below-market interest rate by means of a HUD-determined adjustment factor. The
purpose of this program is to provide incentives to owners of properties with
expiring Section 8 HAP contracts not to convert these properties to market rate
housing.
In return for receiving market rate rents under Mark-up-to-Market, the
property owner must enter into a five year conditional Section 8 HAP contract
with HUD, subject to the annual availability of funding by Congress. In
addition, property owners who enter into the Mark-up-to- Market program may
receive increased cash flow as the limited dividend will be increased in an
amount equal to the increase in gross rental revenues.
Mercy Terrace Associates (Mercy Terrace) has a Section 8 HAP contract
covering 100% of its apartment units which expires in November 2003. The Local
Managing General Partner will enter Mercy Terrace into the Mark-up-to-Market
program at that time. With the renewal of the Section 8 HAP contract under the
Mark-up-to-Market program the limitation on the amount of allowable
distributions will be lifted. However, due to a significant ground lease and a
purchase money note on the property, it is unlikely that the Local Partnership
(and therefore the Partnership) will receive increased cash flow from surplus
cash distributions. Posada Associates Limited Partnership (Posada Vallarta) has
a Section 8 HAP contract covering 21% of its apartment units which expires in
February 2004. Posada Vallarta anticipates a one-year renewal of its Section 8
HAP contract at expiration. As of September 30, 2003, the carrying amount of the
Partnership's investments in and advances to Local Partnerships with Section 8
HAP contracts expiring in the next 12 months was $0.
The Managing General Partner continues to seek strategies to deal with
affordable housing policy. While the Managing General Partner cannot predict the
outcome for any particular property at this time, the Managing General Partner
will continue to work with the Local Partnerships to develop strategies that
maximize the benefits to investors.
Financial Condition/Liquidity
-----------------------------
The Partnership's liquidity, with unrestricted cash resources of $4,508,484
as of September 30, 2003, along with anticipated future cash distributions from
the Local Partnerships, is expected to be adequate to meet its current and
anticipated operating cash needs. As of November 4, 2003, there were no material
commitments for capital expenditures. The Managing General Partner has approved
distributions totaling $1,389,570 to be paid in November 2003 (see Item 5,
below, for additional information concerning these distributions).
The Partnership's remaining obligation with respect to its investment in
Local Partnerships, in the form of a nonrecourse purchase money note having a
principal balance of $1,400,000 plus accrued interest of $2,594,762 as of
September 30, 2003, was payable in full at maturity on September 1, 2003. The
purchase money note, which is nonrecourse to the Partnership, is secured solely
by the Partnership's interest in the related Local Partnership, Westgate Tower
Limited Dividend Housing Association (Westgate). The Partnership's investment in
Westgate has not produced sufficient value to satisfy the purchase money note,
and the Managing General Partner has offered to tender the Partnership's
interest in Westgate to the purchase money noteholders. See the notes to
financial statements for additional information concerning this purchase money
note.
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Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
-------------------------------------------------------
and Results of Operations - Continued
-------------------------
The Partnership's inability to pay the purchase money note principal and
accrued interest balance when due, and the resulting uncertainty regarding the
Partnership's continued ownership interest in Westgate, does not adversely
impact the Partnership's financial condition because the purchase money note is
nonrecourse and secured solely by the Partnership's interest in Westgate.
Therefore, even though the investment in Westgate has not produced sufficient
value to satisfy the related purchase money note, the Partnership's exposure to
loss is limited because the amount of the nonrecourse indebtedness of the
maturing purchase money note exceeds the carrying amount of the investment in
Westgate. Thus, even a complete loss of the Partnership's interest in Westgate
would not have a material adverse impact on the financial condition of the
Partnership. In the event of a foreclosure or other transfer of the
Partnership's interest, the excess of the nonrecourse indebtedness over the
carrying amount of the Partnership's investment in Westgate will result in
taxable gain. This gain will be taxable to Limited Partners at a federal tax
rate of up to 25%, as it will reflect recapture of depreciation deductions
claimed in prior years. Additionally, in the event of a foreclosure or other
transfer of the Partnership's interest, the Partnership would lose its
investment in Westgate and, likewise, its share of any future cash flow
distributed by Westgate from rental operations, mortgage debt refinancings, or
the sale of the real estate. The Partnership received no cash distributions from
Westgate during 2002 and through November 4, 2003; thus, in the event of a
foreclosure or other transfer of the Partnership's interest, there would be no
material adverse impact on the cash liquidity of the Partnership.
The sale of the Partnership's interest in Princeton Community Village
Associates (Princeton) over a four year period did not affect the Partnership's
cash liquidity, since the only consideration received was the cancellation of
portions of purchase money note principal and accrued interest. The Partnership
did not receive any cash distributions from Princeton during this four year
period.
The Partnership closely monitors its cash flow and liquidity position in an
effort to ensure that sufficient cash is available for operating requirements.
For the nine month period ended September 30, 2003, the receipt of distributions
from Local Partnerships was adequate to support operating cash requirements.
Cash and cash equivalents increased $1,087,995 during the nine month period
ended September 30, 2003, primarily as a result of distributions received from
Local Partnerships exceeding net cash used in operating activities. For the nine
months ended September 30, 2003, $599,651 of the distributions received were
from Local Partnerships for which the Partnership's carrying value is zero
(equity method suspended). The Partnership expects to receive a lower amount of
distributions from these Local Partnerships in future years as more Section 8
HAP contracts approach expiration, should the related properties enter the
Mark-to-Market program with the resulting reduction in rental revenue.
After the distributions to be made in November 2003, the Managing General
Partner intends to retain all of the Partnership's remaining undistributed cash
for operating cash reserves.
Results of Operations
---------------------
The Partnership's net income for the three month period ended September 30,
2003, decreased $2,445,960 from the corresponding period in 2002 primarily due
to gain on disposition of investment in partnership during the 2002 period, a
decrease in interest revenue due to declining interest rates and a nominal
increase in professional fees. Partially offsetting the decrease in net income
was an increase in share of income from partnerships, a decrease in interest
expense due to lower purchase money note balances, and nominal decreases in
general and administrative expenses and amortization of deferred costs. The
increase in share of income from partnerships was the result of an increase in
rental revenue at the property related to one Local Partnership, partially
offset by an increase in operating expenses related to maintenance costs at
another property, and an increase in cash distributions recorded as income from
Local Partnerships for which the Partnership's carrying value is zero (equity
method suspended).
-12-
Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
-------------------------------------------------------
and Results of Operations - Continued
-------------------------
The Partnership's net income for the nine month period ended September 30,
2003, decreased $2,307,533 from the corresponding period in 2002, primarily due
to gain on disposition of investment in partnership during the 2002 period, a
decrease in interest revenue, as discussed above, an increase in general and
administrative expenses related to higher reimbursed payroll costs, and an
increase in professional fees. Partially offsetting the decrease in net income
were an increase in share of income from partnerships, a decrease in interest
expense, as discussed above, an increase in gain on extinguishment of debt and a
nominal decrease in amortization of deferred costs. The increase in share of
income from partnerships was the net result of: (i) increases in rental revenue
at the properties related to two Local Partnerships and a decrease in operating
expenses at one of them; (ii) decreases in real estate taxes, property insurance
expense and maintenance costs at the property related to one Local Partnership;
(iii) an increase in operating expenses at the property related to one Local
Partnership; (iv) decreases in cash distributions recorded as income from three
Local Partnerships for which the Partnership's carrying value is zero (equity
method suspended); and (v) the cessation of income from a Local Partnership
whose related property was sold in September 2002.
For financial reporting purposes, the Partnership, as a limited partner in
the Local Partnerships, does not record losses from the Local Partnerships in
excess of its investment to the extent that the Partnership has no further
obligation to advance funds or provide financing to the Local Partnerships. As a
result, the Partnership's share of income from partnerships for the three and
nine month periods ended September 30, 2003, did not include losses of $332,684
and $962,344, respectively, compared to excluded losses of $274,103 and $822,306
for the three and nine month periods ended September 30, 2002, respectively.
No other significant changes in the Partnership's operations have taken
place during the nine month period ended September 30, 2003.
Item 3. Controls and Procedures
-----------------------
In October 2003, representatives of the Managing General Partner of the
Partnership carried out an evaluation of the effectiveness of the design and
operation of the Partnership's disclosure controls and procedures, pursuant to
Exchange Act Rules 13a-15 and 15d-15. The Managing General Partner does not
expect that the Partnership's disclosure controls and procedures will prevent
all error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Over time,
controls may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected. Based on the October 2003
evaluation, and subject to the foregoing, the Principal Executive Officer and
Principal Financial Officer concluded that the Partnership's disclosure controls
and procedures are effective as of the end of the period covered by this report
to alert them in a timely manner to any material information relating to the
Partnership that must be included in the Partnership's periodic SEC filings, and
particularly during the period in which this report is being prepared. In
addition, there have been no significant changes in the Partnership's internal
control over financial reporting that occurred during the Partnership's most
recent fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Partnership's internal control over financial reporting.
-13-
Part I. FINANCIAL INFORMATION
Item 3. Defaults Upon Senior Securities
-------------------------------
See Note 2.a. of the notes to financial statements contained in Part I,
Item 1, hereof, for information concerning the Partnership's defaults on certain
purchase money notes.
Item 5. Other Information
-----------------
There is no established market for the purchase and sale of units of
additional limited partner interest (Units) in the Partnership, although various
informal secondary market services exist. Due to the limited markets, however,
investors may be unable to sell or otherwise dispose of their Units.
Unregistered Tender Offers
--------------------------
On May 23, 2003, Equity Resource Fund XXII (Equity) initiated an
unregistered tender offer to purchase up to 1,200 of the outstanding Units in
the Partnership at a price of $120 per Unit; the offer expired June 23, 2003. On
April 11, 2003, Equity initiated an unregistered tender offer to purchase up to
1,200 of the outstanding Units in the Partnership at a price of $120 per Unit;
the offer expired May 12, 2003. Equity is not affiliated with the Partnership or
the Managing General Partner. The prices offered were determined solely at the
discretion of Equity and do not necessarily represent the fair market value of
each Unit.
On March 14, 2003, Peachtree Partners (Peachtree) initiated an unregistered
tender offer to purchase an unspecified number of the outstanding Units in the
Partnership at a price of $100 per Unit; the offer expired April 18, 2003.
Peachtree is not affiliated with the Partnership or the Managing General
Partner. The price offered was determined solely at the discretion of Peachtree
and does not necessarily represent the fair market value of each Unit.
The Managing General Partner did not express any opinion and remained
neutral toward the unregistered tender offers for the purchase of Units
described above.
Cash Distributions
------------------
The Managing General Partner has approved a cash distribution of $1,347,570
($27 per Unit) to Limited Partner holders of record as of November 1, 2003, and
a cash distribution of $42,000 to General Partners. The distributions are from
cash resources accumulated from operations and distributions from Local
Partnerships, and will be paid in November 2003.
-14-
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a. Exhibits
Exhibit No. Description
----------- -----------
31.1 Certification of Principal Executive Officer,
pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification of Principal Financial Officer,
pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32 Certification of Principal Executive
Officer and Principal Financial Officer,
pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
b. No reports on Form 8-K were filed with the Commission during the
quarter ended September 30, 2003.
All other Items are not applicable.
-15-
SIGNATURE
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CAPITAL REALTY INVESTORS-II LIMITED
PARTNERSHIP
----------------------------------------------
(Registrant)
by: C.R.I., Inc.
-----------------------------------------
Managing General Partner
November 4, 2003 by: /s/ Michael J. Tuszka
- ---------------- ------------------------------------
DATE Michael J. Tuszka
Vice President
and Chief Accounting Officer
(Principal Financial Officer
and Principal Accounting Officer)
-16-