FORM 10-QSB UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2000 -------------- Commission file number 0-11973 -------------- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP - -------------------------------------------------------------------------- (Exact name of small business issuer as specified in its charter) Maryland 52-1321492 - ----------------------------------------- ------------------------ (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 - -------------------------------------------------------------------------- (Issuer's telephone number, including area code) 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, and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. Not applicable Not applicable - -------------------------- --------------------------------------- (Class) (Outstanding at March 31, 2000) CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP INDEX TO FORM 10-QSB FOR THE QUARTER ENDED MARCH 31, 2000 PAGE ---- PART I. Financial Information Item 1. Financial Statements Balance Sheets - March 31, 2000 and December 31, 1999 . . . . . . . . . . . . . 1 Statements of Operations and Accumulated Losses - for the three months ended March 31, 2000 and 1999 . . . . . . . . . . . . . . . . . 2 Statements of Cash Flows - for the three months ended March 31, 2000 and 1999 . . . 3 Notes to Financial Statements - March 31, 2000 and 1999 . . . . . . . . . . . . . . . . . 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . 21 PART II. Other Information Item 3. Defaults Upon Senior Securities . . . . . . . 26 Item 5. Other Information . . . . . . . . . . . . . . 26 Item 6. Exhibits and Reports on Form 8-K . . . . . . 26 Signature . . . . . . . . . . . . . . . . . . . . . . 27 Exhibit Index . . . . . . . . . . . . . . . . . . . . . 28 PART I. FINANCIAL INFORMATION --------------------- ITEM 1. FINANCIAL STATEMENTS --------------------- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP BALANCE SHEETS ASSETS March 31, December 31, 2000 1999 ------------ ------------ (Unaudited) Investments in and advances to partnerships $ 811,695 $ 966,378 Investment in partnerships held for sale 196,986 -- Cash and cash equivalents 7,950,149 8,936,520 Acquisition fees, principally paid to related parties, net of accumulated amortization of $315,013 and $408,934, respectively 260,409 348,795 Property purchase costs, net of accumulated amortization of $249,024 and $280,099, respectively 217,247 252,283 Other assets 1,272 -- ------------ ------------ Total assets $ 9,437,758 $ 10,503,976 ============ ============ LIABILITIES AND PARTNERS' DEFICIT Due on investments in partnerships $ 7,348,747 $ 7,348,747 Accrued interest payable 22,649,942 22,374,877 Distribution payable -- 1,622,237 Accounts payable and accrued expenses 75,610 127,692 ------------ ------------ Total liabilities 30,074,299 31,473,553 ------------ ------------ Commitments and contingencies Partners' capital (deficit): 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 (6,072,409) (6,072,409) Offering costs (5,278,980) (5,278,980) Accumulated losses (59,302,152) (59,635,188) ------------ ------------ Total partners' deficit (20,636,541) (20,969,577) ------------ ------------ Total liabilities and partners' deficit $ 9,437,758 $ 10,503,976 ============ ============ 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 March 31, ----------------------------- 2000 1999 ------------ ------------ Share of income from partnerships $ 652,260 $ 1,545,651 ------------ ------------ Other revenue and expenses: Revenue: Interest income 107,533 77,182 ------------ ------------ Expenses: Interest 275,065 430,303 Management fee 62,499 62,499 General and administrative 53,162 62,621 Professional fees 25,281 19,348 Amortization of deferred costs 10,750 11,444 ------------ ------------ 426,757 586,215 ------------ ------------ Total other revenue and expenses (319,224) (509,033) ------------ ------------ Income before extraordinary gain from extinguishment of debt 333,036 1,036,618 Extraordinary gain from extinguishment of debt -- 524,994 ------------ ------------ Net income 333,036 1,561,612 Accumulated losses, beginning of period (59,635,188) (72,713,687) ------------ ------------ Accumulated losses, end of period $(59,302,152) $(71,152,075) ============ ============ Net income allocated to General Partners (1.51%) $ 5,029 $ 23,580 ============ ============ Net income allocated to Initial and Special Limited Partners (1.49%) $ 4,962 $ 23,268 ============ ============ Net income allocated to Additional Limited Partners (97%) $ 323,045 $ 1,514,764 ============ ============ Net income per unit of Additional Limited Partner Interest based on 50,000 units outstanding $ 6.46 $ 30.30 ============ ============ 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 three months ended March 31, ----------------------------- 2000 1999 ----------- ----------- Cash flows from operating activities: Net income $ 333,036 $ 1,561,612 Adjustments to reconcile net income to net cash used in operating activities: Share of income from partnerships (652,260) (1,545,651) Amortization of deferred costs 10,750 11,444 Extraordinary gain from extinguishment of debt -- (524,994) Changes in assets and liabilities: Increase in other assets (1,272) (3,388) Increase in accrued interest payable 275,065 430,303 Decrease in accounts payable and accrued expenses (52,082) (37,519) ----------- ----------- Net cash used in operating activities (86,763) (108,193) ----------- ----------- Cash flows from investing activities: Receipt of distributions from partnerships 722,629 3,734,355 Advances made to local partnerships -- (120,642) ----------- ----------- Net cash provided by investing activities 722,629 3,613,713 ----------- ----------- Cash flows from financing activities: Payoff of purchase money notes and related interest -- (1,085,000) Payment of purchase money note principal -- (2,691,176) Distribution to Additional Limited Partners (1,622,237) -- ----------- ----------- Net cash used in financing activities (1,622,237) (3,776,176) ----------- ----------- Net decrease in cash and cash equivalents (986,371) (270,656) Cash and cash equivalents, beginning of period 8,936,520 7,596,031 ----------- ----------- Cash and cash equivalents, end of period $ 7,950,149 $ 7,325,375 =========== =========== Supplemental disclosure of cash flow information: Cash paid during the period for interest $ -- $ 244,822 =========== =========== The accompanying notes are an integral part of these financial statements. -3- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (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 March 31, 2000, and the results of its operations and its cash flows for the three months ended March 31, 2000 and 1999. The results of operations for the interim period ended March 31, 2000, are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-QSB. Certain information and accounting policies and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States 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, 1999. 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS a. Due on investments in partnerships ---------------------------------- The Partnership's obligations with respect to its investments in Local Partnerships, in the form of purchase money notes having an aggregate principal balance of $7,348,747 plus aggregate accrued interest of $22,649,942 as of March 31, 2000, are payable in full upon the earliest of: (1) sale or refinancing of the respective Local Partnership's rental property; (2) payment in full of the respective Local Partnership's permanent loan; or (3) maturity. Purchase money notes in the principal amounts of $1,050,000 and $950,000 matured on December 31, 1996 and 1997, respectively, and were extended to January 5, 2001, but were paid off, at a discount, on September 30, 1999. Purchase money notes in the aggregate principal amount of $2,380,000 matured on January 1, 1998, and were written off on October 5, 1999 when the related local partnership interests, held by the Partnership, were transferred to the noteholders in full satisfaction of the purchase money notes' principal and accrued interest. A purchase money note in the principal amount of $3,150,000 matured on June 1, 1998, and has not been paid or extended. Purchase money notes in the original principal amounts of $4,600,000 and $1,927,500 matured on August 31, 1998, were partially paid down, with the balances extended to August 31, 2003. A purchase money note in the principal amount of $1,450,000 matured on September 1, 1998, and has not been paid or extended. Purchase money notes in the aggregate principal amount of $840,178 matured on January 1, 1999 and were paid off, at a discount, on February 5, 1999. A purchase money note in the principal amount of $500,000 matured on January 1, 1999 and has been extended to January 1, 2004, as discussed below. The purchase money notes, which are nonrecourse to the Partnership, are generally secured by the Partnership's interest in the respective Local Partnerships. There is no assurance that the underlying properties will have -4- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued sufficient appreciation and equity to enable the Partnership to pay the purchase money notes' principal and accrued interest when due. If a purchase money note is not paid in accordance with its terms, the Partnership will either have to renegotiate the terms of repayment or risk losing its partnership interest in the respective Local Partnership. The Partnership's inability to pay certain of the purchase money note principal and accrued interest balances when due, and the resulting uncertainty regarding the Partnership's continued ownership interest in the related Local Partnerships, does not adversely impact the Partnership's financial condition because the purchase money notes are nonrecourse and secured solely by the Partnership's interest in the related Local Partnerships. Therefore, should the investment in any of the Local Partnerships with maturing purchase money notes not produce sufficient value to satisfy the related purchase money notes, the Partnership's exposure to loss is limited because the amount of the nonrecourse indebtedness of each of the maturing purchase money notes exceeds the carrying amount of the investment in, and advances to, each of the related Local Partnerships. Thus, even a complete loss of the Partnership's interest in one of these Local Partnerships would not have a material adverse impact on the financial condition of the Partnership. See further discussion of certain purchase money notes, below. The following chart presents information related to purchase money notes which have matured through March 31, 2000, and which remain unpaid or unextended as of May 10, 2000. Excluded from the following chart are purchase money notes which matured through March 31, 2000, and which have been paid off, cancelled, or extended on or before May 10, 2000. -5- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Carrying Amount Aggregate of Partnership's Aggregate Accrued Investment in Number of Principal Interest and Advances to Purchase Underlying Balance Balance Underlying Local Money Note Local Percentage as of March Percentage as of March Percentage Partnerships as Percentage (PMN) Maturity Partnerships of Total 31, 2000 of Total 31, 2000 of Total March 31, 2000 of Total - ---------------- ------------ ---------- ----------- ---------- ------------- ---------- ---------------- ---------- 2nd Quarter 1998 1 6% $ 3,150,000 43% $ 5,707,059 25% -- -- 3rd Quarter 1998 1 6% 1,450,000 20% 2,163,887 10% $ 715,275 88% ---- ----- ----------- ----- ----------- ----- ---------- ----- 2 12% $ 4,600,000 63% $ 7,870,946 35% $ 715,275 88% ==== ===== =========== ===== =========== ===== ========== ===== Total, Local Partnerships 17 100% $ 7,348,747 100% $22,649,942 100% $ 811,695 100% ==== ===== =========== ===== =========== ===== ========== ===== The Managing General Partner is continuing to investigate possible alternatives to reduce the Partnership's debt obligations. These alternatives include, among others, retaining the cash available for distribution to meet the purchase money note requirements, paying off certain purchase money notes at a discounted price, extending the due dates of certain purchase money notes, refinancing the respective properties' underlying debt or selling the underlying real estate and using the Partnership's share of the proceeds to pay or buy down certain purchase money note obligations. Although the Managing General Partner has had some success applying these strategies in the past, the Managing General Partner cannot assure that these strategies will be successful in the future. If the Managing General Partner is unable to negotiate an extension or discounted payoff, upon maturity of the purchase money notes, in the event that the purchase money notes remain unpaid, the noteholders may have the right to foreclose on the Partnership's interest in the related Local Partnerships. In the event of a foreclosure, the excess of the nonrecourse indebtedness over the carrying amount of the Partnership's investment in the related Local Partnership would be deemed cancellation of indebtedness income which would be taxable to Limited Partners at a federal tax rate of up to 39.6%. Additionally, in the event of a foreclosure, the Partnership would lose its investment in the Local Partnership and, likewise, its share of any future cash flow distributed by the Local Partnership from rental operations, mortgage debt refinancings, or the sale of the real estate. Of the 17 Local Partnerships in which the Partnership is invested as of March 31, 2000, the two Local Partnerships with associated purchase money notes which have matured and which remain unpaid or unextended as of May 10, 2000, represented the following percentages of the Partnership's total distributions received from Local Partnerships and share of income from Local Partnerships for the immediately preceding two calendar years. -6- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Percentage of Total Partnership's Share of Distributions Received Income (loss) from For the Years Ending from Local Partnerships Local Partnerships -------------------- ----------------------- ---------------------- December 31, 1999 1% $ 17,578 December 31, 1998 1% $234,121 The Managing General Partner continues to address the maturity and impending maturity of its debt obligations and to seek strategies which will provide the most favorable outcome to the limited partners. However, there can be no assurance that these strategies will be successful. Interest expense on the Partnership's purchase money notes was $275,065 and $430,303 for the three months ended March 31, 2000 and 1999, respectively. The accrued interest payable on the purchase money notes of $22,649,942 and $22,374,877 as of March 31, 2000 and December 31, 1999, 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 agreements. Beech Hill I and II ------------------- The Partnership defaulted on its purchase money notes aggregating $2,380,000 related to Beech Hill Development Co. (Beech Hill I) and Beech Hill Development Co. II (Beech Hill II) on August 1, 1995 when the notes matured and were not paid. On March 29, 1996, the noteholders agreed to extend the purchase money note due dates to January 1, 1998. Under the agreement, the Partnership paid the noteholders of Beech Hill I and Beech Hill II all annual cash flow distributions received from the related Local Partnerships in excess of $5,000 and $2,500, respectively, to be applied against the notes. Cash flow distributions of $0 and $30,694 were paid directly by Beech Hill I to the purchase money noteholders during the years ended December 31, 1999 and 1998, respectively. Cash flow distributions of $0 and $29,687 were paid directly by Beech Hill II to the purchase money noteholders during the years ended December 31, 1999 and 1998, respectively. Annual cash flow distributions of $0 and $5,000 from Beech Hill I, and $0 and $2,500 from Beech Hill II, were received during the years ended December 31, 1999 and 1998, respectively. Under the extension agreement, documents transferring the Partnership's interests in Beech Hill I and Beech Hill II to the noteholders were placed in escrow to be released to the noteholders upon a future default by the Partnership on the respective purchase money notes. On January 1, 1998, the -7- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Partnership defaulted on its purchase money notes related to Beech Hill I and Beech Hill II when the notes, as extended, matured and were not paid. The default amount included principal and accrued interest of $1,480,000 and $1,687,578, respectively, for Beech Hill I and $900,000 and $1,072,113, respectively, for Beech Hill II. On September 30, 1999, the noteholders instructed the escrow agent to release to them the transfer documents on October 5, 1999, and the escrow agent complied with those instructions. Accordingly, the Partnership's interests in Beech Hill I and Beech Hill II were transferred to the noteholders on October 5, 1999. As of that date, principal and accrued interest totaling $1,480,000 and $1,891,535, respectively, related to Beech Hill I and $900,000 and $1,185,119, respectively, related to Beech Hill II were due. The purchase money notes related to Beech Hill I and Beech Hill II were nonrecourse and secured solely by the Partnership's interests in the related Local Partnerships. The release of the Partnership's purchase money note obligations as a result of the loss of ownership interest in the Local Partnerships resulted in extraordinary gain from extinguishment of debt of approximately $2.4 million and $1.5 million for Beech Hill I and Beech Hill II, respectively, during 1999. The release of the Partnership's purchase money note obligations resulted in cancellation of indebtedness income of approximately $3.4 million and $2.1 million for Beech Hill I and Beech Hill II, respectively, for federal tax purposes in 1999. Chevy Chase ----------- The Partnership defaulted on its two purchase money notes related to Chevy Chase Park, Limited (Chevy Chase) on December 31, 1996 when the notes matured and were not paid. The aggregate default amount included principal and accrued interest of $2,100,000 and $3,553,912, respectively. The Managing General Partner successfully negotiated an extension of one of the purchase money notes (First Chase Note) in the principal amount of $1,050,000 effective December 1, 1997. In connection with the extension agreement, the Partnership made an interest payment to the noteholder. The terms of the extension agreement extended the maturity date to January 2, 2000. On December 17, 1998, the Partnership exercised its right, pursuant to the extension agreement, to further extend the maturity date to January 5, 2001 by making an additional payment, applied to accrued interest, to the noteholder. On February 10, 1998, the Partnership was served with a complaint by the two holders of the second purchase money note (Second Chase Note) filing suit against the Partnership, the Managing General Partner and C.R.H.C., Incorporated (CRHC), an affiliate of the Managing General Partner, for damages and seeking foreclosure on the Partnership's interest in the Local Partnership. On July 29, 1998, the parties agreed to a settlement which involved a discounted payoff to the holders of the Second Chase Note, subject to the Partnership's satisfaction with the results of its due diligence. On October 5, 1998, pursuant to such settlement agreement, the Partnership paid the holders of the Second Chase Note a discounted amount in full settlement of the Second Chase Note and the lawsuit. In connection with this settlement, the local general partners withdrew from the Local Partnership, assigning their combined one percent interests (which were converted to a limited partner interest) in the Local Partnership to the -8- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Partnership, and the property management agent, which is an affiliate of the local general partners, was terminated effective April 1, 1999. CRHC is the sole remaining general partner of the Local Partnership. Further, the Partnership received the interests of the local general partners, the holders of the Second Chase Note, and their respective affiliates in the First Chase Note, which is approximately 10.808%. On May 28, 1999, the Partnership filed suit against the holder of the First Chase Note, seeking payment of the Partnership's 10.808% share of payments made on the First Chase Note since October 1, 1997. On September 30, 1999, as part of the settlement of the litigation, the Partnership paid off, at a discount, the First Chase Note. The discounted payoff resulted in extraordinary gain from extinguishment of debt of approximately $2.4 million in 1999. The discounted payoff also resulted in cancellation of indebtedness income of approximately $2.4 million for federal tax purposes in 1999. On December 30, 1999, the Partnership was served with a complaint by certain alleged beneficiaries of the First Chase Note for, among other relief, their portion of payments made to First March Realty Corporation on the First Chase Note. The Managing General Partner is vigorously defending its position that all such payments were made to the proper parties, and that it has no further responsibility or liability for payments made on the First Chase Note. Four Winds West --------------- The Partnership defaulted on its purchase money note related to Four Winds West Company Limited (Four Winds West) on January 1, 1999 when the note matured and was not paid. The default amount included aggregate principal and accrued interest of $462,178 and $532,673, respectively. On February 5, 1999, the Partnership paid off, at a discount, the purchase money note related to Four Winds West. The discounted payoff resulted in extraordinary gain from extinguishment of debt of approximately $305,000 in 1999. The discounted payoff also resulted in cancellation of indebtedness income of approximately $305,000 for federal tax purposes in 1999. Frenchman's Wharf II -------------------- The Partnership defaulted on its purchase money notes related to Frenchman's Wharf Associates II Limited Partnership (Frenchman's Wharf II) on June 1, 1998 when the notes matured and were not paid. The default amount included principal and accrued interest of $3,150,000 and $5,071,731, respectively. As of May 10, 2000, principal and accrued interest totaling $3,150,000 and $5,744,454, respectively, were due. The purchase money notes were initially due to mature on June 1, 1988, but were extended to mature on June 1, 1998. The Partnership requested another extension of the maturity date of the purchase money notes until May 2000, to be coterminous with the expiration of the Local Partnership's provisional workout agreement with HUD related to its mortgage loan. In 1996, HUD sold the mortgage loan to a third party lender. The local managing general partner has had several conversations with the lender regarding the upcoming maturity of the workout. There is no assurance these discussions will achieve a resolution of the issue, and it is -9- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued possible the lender will initiate a foreclosure action. As of May 10, 2000, the local managing general partner is still awaiting a response from the purchase money noteholders and the lender. Due to the uncertainties regarding an extension of the maturity date of the purchase money note, and the possibility of a foreclosure proceeding on the Local Partnership's mortgage loan, there is no assurance that the Partnership will be able to retain its interest in Frenchman's Wharf II. In the event of a foreclosure, the Partnership would also lose its share of any future cash flow distributed by the Local Partnership from rental operations, mortgage debt refinancings, or the sale of the real estate. The uncertainty regarding the continued ownership of the Partnership's interest in Frenchman's Wharf II does not adversely impact the Partnership's financial condition, as discussed above. 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 has forfeited its interest in Princeton to the noteholders. 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 partnership 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 notes. 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 is to be applied against accrued interest payable on the purchase money note. Rolling Green at Fall River and Rolling Green at Amherst -------------------------------------------------------- The Partnership defaulted on its purchase money notes related to Roberts Fall River Associates (Rolling Green at Fall River) and Roberts Amherst Associates (Rolling Green at Amherst) on August 31, 1998 when the notes matured and were not paid. The default amount included principal and accrued interest of $4,600,000 and $8,750,764, respectively, for Rolling Green at Fall River and $1,927,500 and $3,661,147, respectively, for Rolling Green at Amherst. The Managing General Partner and the trustees representing the noteholders agreed to extend the maturity dates of the purchase money notes to February 28, 2001, subject to a further extension to August 31, 2003 if the Local Partnerships complete a refinancing of their mortgage loans, which refinancings have occurred. However, the noteholders have the right to accelerate the maturity of the notes upon not less than one year's prior notice. Accordingly, the purchase money notes for Rolling Green at Fall River and Rolling Green at Amherst presently mature on August 31, 2003, subject to the respective noteholder's right to accelerate the maturity. As part of the agreement, the Partnership agreed that all refinancing mortgage loan proceeds payable to the Partnership by -10- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued the respective Local Partnerships, as well as all net cash flow payable to the Partnership from the respective Local Partnerships in excess of $10,000 per year, shall be applied to the balance of the respective purchase money notes, and further agreed to waive certain rights granted in the respective Local Partnerships' limited partnership agreements. The mortgage loan on Rolling Green at Fall River was refinanced in March 1999; refinancing proceeds of $2,725,257 were used to pay down purchase money note principal and capitalized interest in March 1999. The mortgage loan on Rolling Green at Amherst was refinanced in August 1998; refinancing proceeds of $1,503,496 were used to pay down purchase money note principal and capitalized interest in 1998. The local managing general partner has received an offer for the purchase of the property and the parties have executed a sales contract dated as of February 18, 2000. See Note 2.c. for further information concerning this sale. Troy Manor ---------- The Partnership defaulted on its purchase money note related to Troy Apartments Limited (Troy Manor) on January 1, 1999 when the note matured and was not paid. The default amount included aggregate principal and accrued interest of $378,000 and $227,420, respectively. On February 5, 1999, the Partnership paid off, at a discount, the purchase money note related to Troy Manor. The discounted payoff resulted in extraordinary gain from extinguishment of debt of approximately $220,000 in 1999. The discounted payoff also resulted in cancellation of indebtedness income of approximately $220,000 for federal tax purposes in 1999. Westgate -------- In June, 1998, the holder of the purchase money note related to Westgate Tower Limited Dividend Housing Associates (Westgate) accepted the Managing General Partner's offer to extend the maturity date of the purchase money note for five years from its scheduled maturity date of September 1, 1998. However, the noteholder has since refused to execute the documentation formally extending the maturity date. As of May 10, 2000, principal and accrued interest of $1,450,000 and $2,177,971, respectively, were due. In December, 1998, the noteholder's attorney notified the Managing General Partner of its position, which the Managing General Partner disputes, that the noteholder's prior agreement to extend the maturity date is not binding on the noteholder. The noteholder has since agreed to execute the documentation formally extending the maturity date, but as of May 10, 2000, has not yet done so. The Managing General Partner is prepared to vigorously defend its position that the agreement to extend the maturity date for five years is binding on the noteholder. There is no assurance that the parties will be able to settle this dispute or that the Partnership would prevail in any resulting litigation if a settlement is not reached. Accordingly, there can be no assurance that the Partnership will be able to retain its interest in the Local Partnership. The uncertainty about the continued ownership of the Partnership's interest in the related Local Partnership does not adversely impact the Partnership's financial condition, as discussed above. -11- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Wexford Ridge ------------- The Partnership defaulted on its three purchase money notes relating to Wexford Ridge Associates (Wexford Ridge) on December 31, 1997 when the notes matured and were not paid. The aggregate default amount included principal and accrued interest of $1,900,000 and $3,478,549, respectively. The Managing General Partner successfully negotiated an extension on one of the purchase money notes (First Wexford Note) in the principal amount of $950,000 effective April 9, 1998; the First Wexford Note was paid off, at a discount, on September 30, 1999. The discounted payoff resulted in extraordinary gain from extinguishment of debt of approximately $2.4 million in 1999. The discounted payoff also resulted in cancellation of indebtedness income of approximately $2.4 million for federal tax purposes in 1999. On April 7, 1998, the Partnership was served with a complaint by the holder of the second and third purchase money notes (collectively, Second and Third Wexford Notes) filing suit against the Partnership, the Managing General Partner and C.R.H.C., Incorporated (CRHC), an affiliate of the Managing General Partner, for damages and seeking foreclosure on the Partnership's interest in the Local Partnership. On July 29, 1998, the parties agreed to a settlement which involved a discounted payoff to the holder of the Second and Third Wexford Notes, subject to the Partnership's satisfaction with the results of its due diligence. On October 5, 1998, pursuant to such settlement agreement, the Partnership paid the holder of the Second and Third Wexford Notes a discounted amount in full settlement of the Second and Third Wexford Notes and the lawsuit. In connection with this settlement, the local general partner withdrew from the Local Partnership, assigning his one percent interest (which was converted to a limited partner interest) in the Local Partnership to the Partnership, and the property management agent, which is an affiliate of the local general partner, agreed to a termination of the property management agreement effective April 1, 1999. CRHC is the sole remaining general partner of the Local Partnership. Further, the Partnership received the interests of the local general partner, the holder of the Second and Third Wexford Notes, and their respective affiliates in the First Wexford Note, which is approximately 4.85%. On May 28, 1999, the Partnership filed suit against the holder of the First Wexford Note, seeking payment of the Partnership's 4.85% share of payments made on the First Wexford Note since October 1, 1997. On September 30, 1999, as part of the settlement of the litigation, the Partnership paid off, at a discount, the First Wexford Note (see above). b. Advances to Local Partnerships ------------------------------ As of both March 31, 2000 and December 31, 1999, the Partnership had advanced funds to Local Partnerships totaling $474,410. Interest accrued on these advances was $187,372 as of both March 31, 2000 and December 31, 1999. For financial reporting purposes, these loans have been reduced to zero by the Partnership as a result of losses from the related Local Partnerships. -12- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Frenchman's Wharf II -------------------- To cover operating deficits incurred in prior years for Frenchman's Wharf II, the Partnership advanced funds totaling $324,410 as of both March 31, 2000 and December 31, 1999. No advances have been made to Frenchman's Wharf II since March 1987, and the Partnership does not expect to advance any additional funds to the Local Partnership. These loans, together with accrued interest of $187,372 as of both March 31, 2000 and December 31, 1999, are payable from cash flow of Frenchman's Wharf II after payment of first mortgage debt service and after satisfaction by the Partnership of certain other interest obligations on the purchase money notes relating to the Local Partnership. No interest has been accrued since 1992 due to the uncertainty of future collection. There is no assurance that the Local Partnership, upon expiration of the workout of its mortgage loan, will be able to repay the loans in accordance with the terms thereof. For financial reporting purposes, these loans have been reduced to zero by the Partnership as a result of losses at the Local Partnership level during prior years. Posada Vallarta Apartments -------------------------- The Managing General Partner and the local managing general partner of Posada Associates Limited Partnership (Posada Vallarta Apartments) refinanced the property's mortgage loan on May 26, 1998. In connection with such refinancing, the Partnership advanced the Local Partnership $450,000 for application and rate lock fees. As of both March 31, 2000 and December 31, 1999, $300,000 of the advances had been repaid to the Partnership. For financial reporting purposes, the remaining advance has been reduced to zero by the Partnership as a result of losses at the Local Partnership level. c. Property matters ---------------- Chevy Chase ----------- The Managing General Partner and the local managing general partner are both exploring various options to refinance the U. S. Department of Housing and Urban Development (HUD) Section 236 interest rate subsidized mortgage loan related to Chevy Chase, or to enter the Mark-up-to-Market program. The Managing General Partner and local managing general partner are awaiting HUD's analysis of the property and proposal for Mark-up-to-Market. In the event that the property does not enter the Mark-up-to-Market program, consideration will be given to converting the property to market rate over the next 12 to 18 months. There is no assurance that a refinancing of the mortgage loan will occur, that the property will enter the Mark-up-to-Market program, or that it will be converted to market rate. -13- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Frenchman's Wharf II -------------------- The report of the auditors on the financial statements of Frenchman's Wharf II for the year ended December 31, 1999 indicated that substantial doubt exists about the ability of the Local Partnership to continue as a going concern due to the Local Partnership's default on its mortgage loan and the impending expiration of its Section 8 Rental Housing Assistance Payments (HAP) contract with HUD. The contract subsequently was extended for another year. The uncertainty about the Local Partnership's continued ownership of the property does not adversely impact the Partnership's financial condition, as discussed above. Orangewood Plaza ---------------- The 1983 construction loan related to Orangewood Plaza, a 40-unit apartment building in Orange Cove, California, was never formally converted to a permanent loan. It is anticipated that this loan will be restructured, and that the restructuring may result in cancellation of indebtedness income to the Partnership in the amount of approximately $163,000 during 2000. Additionally, the Partnership had pledged its interest in the Local Partnership as security on a promissory note, in the amount of $170,000, made by the Local Partnership. The note, which matured on August 5, 1998, is currently in default. The parties are currently negotiating a restructuring of this loan, which is anticipated to be formalized concurrent with the restructuring of the construction loan. There is no assurance that either restructuring will be formalized. Accordingly, there is no assurance that the Partnership will be able to retain its interest in Orangewood Plaza. This uncertainty does not adversely impact the Partnership's financial condition, as discussed above. Posada Vallarta Apartments -------------------------- The Managing General Partner and the local managing general partner of Posada Vallarta Apartments refinanced the property's mortgage loan on May 26, 1998. In connection with such refinancing, the Partnership advanced the Local Partnership $450,000 for application and rate lock fees. As of both March 31, and December 31, 1999, $300,000 of the advances had been repaid to the Partnership. For financial reporting purposes, the remaining advance has been reduced to zero by the Partnership as a result of losses at the Local Partnership level. Princeton --------- Princeton Community Village Associates (Princeton) defaulted on its project subsidy loan. The maturity date was extended five years to January 1, 2004, as part of litigation settled effective January 1, 2000, when the Managing General Partner and the noteholder entered into an agreement extending the maturity date of the purchase money note, as discussed above. -14- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Rolling Green at Amherst ------------------------ The local managing general partner of Roberts Amherst Associates (Rolling Green at Amherst) has received an offer for the purchase of the property, and the parties have executed a sales contract dated as of February 18, 2000, with a projected closing date in June, 2000. Proceeds received by the Partnership from the sale of this property would be used to pay off, at a discount, the purchase money notes related to Rolling Green at Amherst. The contract is subject to customary contingencies. Accordingly, there is no assurance that a sale or a payoff of the purchase money notes will occur. In the event of a sale of this property, the Partnership's investments in and advances to partnerships would be reduced accordingly. Of the Local Partnerships in which the Partnership was invested as of March 31, 2000 and December 31, 1999, Rolling Green at Amherst represented approximately 6% and 6%, respectively, of the total investments in and advances to partnerships. For the calendar years ended December 31, 1999 and 1998, distributions from Rolling Green at Amherst represented approximately 2% and 0%, respectively, of total distributions from Local Partnerships. The Partnership's share of income from Rolling Green at Amherst was $0 and $6,844 for the three months ended March 31, 2000 and 1999, respectively. Due to the impending and likely sale of the property related to the Partnership's investment in Rolling Green at Amherst, the investment in and advances to partnerships plus net unamortized amounts of acquisition fees and property purchase costs related to Rolling Green at Amherst, which totaled $123,740, have been reclassified to investment in partnerships held for sale in the accompanying balance sheet at March 31, 2000. Rolling Green at Fall River --------------------------- The mortgage loan on Rolling Green at Fall River was refinanced in March 1999; refinancing proceeds of $2,725,257 were used to pay down purchase money note principal and capitalized interest in March 1999. See the discussion above for additional information concerning this refinancing and pay down. The local managing general partner of Roberts Fall River Associates (Rolling Green at Fall River) has received an offer for the purchase of the property, and the parties have executed a sales contract dated as of February 18, 2000, with a projected closing date in June, 2000. Proceeds received by the Partnership from the sale of this property would be used to pay off, at a discount, the purchase money notes related to Rolling Green at Fall River. The contract is subject to customary contingencies. Accordingly, there is no assurance that a sale or a payoff of the purchase money notes will occur. In the event of a sale of this property, the Partnership's investments in and advances to partnerships would be reduced accordingly. Of the Local Partnerships in which the Partnership was invested as of March 31, 2000 and December 31, 1999, Rolling Green at Fall River represented approximately 0% and 3%, respectively, of the total investments in and advances to partnerships. For the calendar years ended December 31, 1999 and 1998, distributions from Rolling Green at Fall River represented approximately 1% and 2%, respectively, of total distributions from Local Partnerships. The Partnership's share of income from -15- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Rolling Green at Fall River was $28,452 and $9,316 for the three months ended March 31, 2000 and 1999, respectively. Due to the impending and likely sale of the property related to the Partnership's investment in Rolling Green at Fall River, the net unamortized amounts of acquisition fees and property purchase costs related to Rolling Green at Fall River, which totaled $73,246, have been reclassified to investment in partnerships held for sale in the accompanying balance sheet at March 31, 2000. d. Summarized financial information -------------------------------- Combined statements of operations for the 17 and 20 Local Partnerships in which the Partnership is invested as of March 31, 2000 and 1999, respectively, follow. The combined statements have been compiled from information supplied by the management agents of the projects and are unaudited. COMBINED STATEMENTS OF OPERATIONS (Unaudited) For the three months ended March 31, ----------------------------- 2000 1999 ------------ ------------ Revenue: Rental $ 5,931,454 $ 6,550,834 Other 213,510 337,527 ------------ ------------ Total revenue 6,144,964 6,888,361 ------------ ------------ Expenses: Operating 3,709,072 4,343,965 Interest 1,680,011 1,624,336 Depreciation and amortization 1,112,016 1,213,666 ------------ ------------ Total expenses 6,501,099 7,181,967 ------------ ------------ Net loss $ (356,135) $ (293,606) ============ ============ As of March 31, 2000 and 1999, the Partnership's share of cumulative losses to date for 11 and 12, respectively, of the 17 and 20 Local Partnerships, respectively, exceeded the amount of the Partnership's investments in and advances to those Local Partnerships by $25,410,195 and $23,952,567, respectively. As the Partnership has no further obligation to advance funds or provide financing to these Local Partnerships, the excess losses have not been -16- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued reflected in the accompanying financial statements. 3. AFFORDABLE HOUSING LEGISLATION 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 one year. Expiring Section 8 HAP contracts with rents that exceed 100% of fair market rents could be renewed for 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 implementation will reduce rental income at properties which are currently subsidized at higher-than-market rental rates, and will therefore lower cash flow available to meet mortgage payments and operating expenses. Each affected property may undergo debt restructuring according to terms determined by an individual property and operations evaluation. This may involve reducing the first mortgage loan balance to an amount supportable by the property, taking into account the property's operating expenses and reduced income. The balance of the amount written down from the first mortgage loan will be converted to a non-performing but accruing (soft) second mortgage loan. The Section 8 HAP contracts for the following properties initially expired during the government's fiscal year 1998 or 1999 or will expire during 2000, and have been renewed as indicated. -17- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 3. AFFORDABLE HOUSING LEGISLATION - Continued Units Authorized for Original Renewed Number of Rental Assistance Under Expiration of Section 8 Expiration of Section 8 Property Rental Units Section 8 HAP Contract HAP Contract - -------- ------------ ----------------------- ----------------------- ----------------------- Chevy Chase 232 228 03/23/98 09/22/00 (1) Country Place II 120 24 08/29/00 (1) Four Winds West 62 62 04/14/98 10/14/00 (1) Frenchman's Wharf II 324 31 11/30/98 11/30/00 (1) Princeton Community Village 239 26 07/01/98 10/01/24 Troy Manor 50 50 10/29/99 10/29/00 (1) ----- --- Total 1,027 421 ===== === (1) The Managing General Partner expects that these Section 8 HAP Contracts will be renewed for one year upon expiration. With the uncertainty of continued project-based Section 8 subsidies for properties with expiring HAP contracts, there is no assurance that these rental properties will be able to maintain the rental income and occupancy levels necessary to pay operating costs and debt service. As a result, it is not possible to predict the impact on the Local Partnerships' operations and the resulting impact on the Partnership's investments in the Local Partnerships at this time. As of March 31, 2000, the Partnership's investments in and advances to Local Partnerships with Section 8 HAP contracts expiring in 2000 was $96,187. There is a new HUD-sponsored program generally referred to as "Mark-up-to- Market." Under this program, properties with expiring Section 8 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 rents in line with market rate rents. For properties which enter the program and which have 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 Interest Subsidy Adjustment Factor. The purpose of this program is to incentivize owners of properties with expiring Section 8 contracts not to convert these properties to market rate housing. -18- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS March 31, 2000 and 1999 (Unaudited) 3. AFFORDABLE HOUSING LEGISLATION - Continued In return for receiving market rate rents under Mark-up-to-Market, the property owner must enter into a five year conditional Section 8 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 will receive a waiver from the cash flow restriction imposed on the property by the limited dividend limitation. 4. 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 managing the Partnership. For the three month periods ended March 31, 2000 and 1999, the Partnership paid $49,857 and $44,356, respectively, 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 (the Management Fee), after all other expenses of the Partnership are paid. For each of the three month periods ended March 31, 2000 and 1999, the Part- nership paid the Managing General Partner a Management Fee of $62,499. The Managing General Partner and/or its affiliates may receive a fee of not more than 2% 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. No such fees were earned by the Managing General Partner or its affiliates for the three months ended March 31, 2000 or 1999. -19- PART I. FINANCIAL INFORMATION --------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND 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 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, terms of governmental regulations that affect the Partnership and interpretations of those regulations, the competitive environment in which the Partnership operates, and the availability of working capital. General ------- Some of the rental properties owned by the Local Partnerships are financed by state housing agencies. The Managing General Partner has been working to develop strategies 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 in perpetuity, 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 one year. Expiring Section 8 HAP contracts with rents that exceed 100% of fair market rents could be renewed for 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 implementation will reduce rental income at properties which are currently subsidized at higher-than-market rental rates, and will therefore lower cash flow available to meet mortgage payments and operating expenses. Each affected property may undergo debt restructuring according to terms determined by an individual property and operations evaluation. This may involve reducing the first mortgage loan balance to an amount supportable by the property, taking into account the property's operating expenses and reduced income. The balance of the amount written down from the first mortgage loan will be converted to a non-performing but accruing (soft) second mortgage loan. -20- PART I. FINANCIAL INFORMATION --------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued ----------------------------------- In many instances, the Mark-to-Market rental rate restructuring may require the write down of an FHA-insured mortgage loan, which would trigger cancellation of indebtedness income to the partners, a taxable event, even though no actual cash is received. Additionally, if 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; however, the Internal Revenue Service issued a ruling in July 1998 that concluded that the below- market rate of interest will not generate additional ordinary income. Each property subject to Mark-to-Market 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. There is a new HUD-sponsored program generally referred to as "Mark-up-to- Market". Under this program, properties with expiring Section 8 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 rents in line with market rate rents. For properties which enter the program and which have 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 Interest Subsidy Adjustment Factor. The purpose of this program is to incentivize owners of properties with expiring Section 8 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 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 will receive a waiver from the cash flow restriction imposed on the property by the limited dividend limitation. The Managing General Partner is considering new strategies to deal with the ever changing environment of affordable housing policy. The Section 236 and Section 221(d)(3) mortgage loans may be eligible for pre-payment in their 18th year or later. Properties with expiring Section 8 HAP contracts may become convertible to market rate apartment properties. Currently, there are few lenders that will provide financing either to prepay existing mortgage loans of these types or provide additional funds to allow a property to convert to market rate units. Where opportunities exist, the Managing General Partner will continue to work with the Local Partnerships to develop strategies that make economic sense for all parties involved. Financial Condition/Liquidity ----------------------------- The Partnership's liquidity, with unrestricted cash resources of $7,950,149 and $8,936,520 as of March 31, 2000 and December 31, 1999, respectively, 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 May 10, 2000, there were no material commitments for capital expenditures. The Partnership's obligations with respect to its investments in Local Partnerships, in the form of purchase money notes having an aggregate principal balance of $7,348,747 plus aggregate accrued interest of $22,649,942 as of March 31, 2000, are payable in full upon the earliest of: (1) sale or refinancing of the respective Local Partnership's rental property; (2) payment in full of the -21- PART I. FINANCIAL INFORMATION --------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued ----------------------------------- respective Local Partnership's permanent loan; or (3) maturity. Purchase money notes in the principal amounts of $1,050,000 and $950,000 matured on December 31, 1996 and 1997, respectively, and were extended to January 5, 2001, but were paid off, at a discount, on September 30, 1999. Purchase money notes in the aggregate principal amount of $2,380,000 matured on January 1, 1998, and were written off on October 5, 1999 when the related local partnership interests, held by the Partnership, were transferred to the noteholders in full satisfaction of the purchase money notes' principal and accrued interest. A purchase money note in the principal amount of $3,150,000 matured on June 1, 1998, and has not been paid or extended. Purchase money notes in the original principal amounts of $4,600,000 and $1,927,500 matured on August 31, 1998, were partially paid down, with the balances extended to August 31, 2003. A purchase money note in the principal amount of $1,450,000 matured on September 1, 1998, and has not been paid or extended. Purchase money notes in the aggregate principal amount of $840,178 matured on January 1, 1999 and were paid off, at a discount, on February 5, 1999. A purchase money note in the principal amount of $500,000 matured on January 1, 1999 and has been extended to January 1, 2004. See the notes to the financial statements for additional information concerning these purchase money notes. The purchase money notes, which are nonrecourse to the Partnership, are generally secured by the Partnership's interest in the respective Local Partnerships. There is no assurance that the underlying properties will have sufficient appreciation and equity to enable the Partnership to pay the purchase money notes' principal and accrued interest when due. If a purchase money note is not paid in accordance with its terms, the Partnership will either have to renegotiate the terms of repayment or risk losing its partnership interest in the respective Local Partnership. The Partnership's inability to pay certain of the purchase money note principal and accrued interest balances when due, and the resulting uncertainty regarding the Partnership's continued ownership interest in the related Local Partnerships, does not adversely impact the Partnership's financial condition because the purchase money notes are nonrecourse and secured solely by the Partnership's interest in the related Local Partnerships. Therefore, should the investment in any of the Local Partnerships with maturing purchase money notes not produce sufficient value to satisfy the related purchase money notes, the Partnership's exposure to loss is limited because the amount of the nonrecourse indebtedness of each of the maturing purchase money notes exceeds the carrying amount of the investment in, and advances to, each of the related Local Partnerships. Thus, even a complete loss of the Partnership's interest in one of these Local Partnerships would not have a material adverse impact on the financial condition of the Partnership. The following chart presents information related to purchase money notes which have matured through March 31, 2000, and which remain unpaid or unextended as of May 10, 2000. Excluded from the following chart are purchase money notes which matured through March 31, 2000, and which have been paid off, cancelled, or extended on or before May 10, 2000. -22- PART I. FINANCIAL INFORMATION --------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued ----------------------------------- Carrying Amount Aggregate of Partnership's Aggregate Accrued Investment in Number of Principal Interest and Advances to Purchase Underlying Balance Balance Underlying Local Money Note Local Percentage as of March Percentage as of March Percentage Partnerships as Percentage (PMN) Maturity Partnerships of Total 31, 2000 of Total 31, 2000 of Total March 31, 2000 of Total - ---------------- ------------ ---------- ----------- ---------- ------------- ---------- ---------------- ---------- 2nd Quarter 1998 1 6% $ 3,150,000 43% $ 5,707,059 25% -- -- 3rd Quarter 1998 1 6% 1,450,000 20% 2,163,887 10% $ 715,275 88% ---- ----- ----------- ----- ----------- ----- ---------- ----- 2 12% $ 4,600,000 63% $ 7,870,946 35% $ 715,275 88% ==== ===== =========== ===== =========== ===== ========== ===== Total, Local Partnerships 17 100% $ 7,348,747 100% $22,649,942 100% $ 811,695 100% ==== ===== =========== ===== =========== ===== ========== ===== The Managing General Partner is continuing to investigate possible alternatives to reduce the Partnership's debt obligations. These alternatives include, among others, retaining the cash available for distribution to meet the purchase money note requirements, paying off certain purchase money notes at a discounted price, extending the due dates of certain purchase money notes, refinancing the respective properties' underlying debt or selling the underlying real estate and using the Partnership's share of the proceeds to pay or buy down certain purchase money note obligations. Although the Managing General Partner has had some success applying these strategies in the past, the Managing General Partner cannot assure that these strategies will be successful in the future. If the Managing General Partner is unable to negotiate an extension or discounted payoff, upon maturity of the purchase money notes, in the event that the purchase money notes remain unpaid, the noteholders may have the right to foreclose on the Partnership's interest in the related Local Partnerships. In the event of a foreclosure, the excess of the nonrecourse indebtedness over the carrying amount of the Partnership's investment in the related Local Partnership would be deemed cancellation of indebtedness income which would be taxable to Limited Partners at a federal tax rate of up to 39.6%. Additionally, in the event of a foreclosure, the Partnership would lose its investment in the Local Partnership and, likewise, its share of any future cash flow distributed by the Local Partnership from rental operations, mortgage debt refinancings, or the sale of the real estate. Of the 17 Local Partnerships in which the Partnership is invested as of March 31, 2000, the two Local Partnerships with associated purchase money notes which have matured and which remain unpaid or unextended as of May 10, 2000, represented the following percentages of the Partnership's total distributions received from Local Partnerships and share of income from Local Partnerships for the immediately preceding two calendar years. -23- PART I. FINANCIAL INFORMATION --------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued ----------------------------------- Percentage of Total Partnership's Share of Distributions Received Income (loss) from For the Years Ending from Local Partnerships Local Partnerships -------------------- ----------------------- ---------------------- December 31, 1999 1% $ 17,578 December 31, 1998 1% $234,121 The Managing General Partner continues to address the maturity and impending maturity of its debt obligations and to seek strategies which will provide the most favorable outcome to the limited partners. However, there can be no assurance that these strategies will be successful. Interest expense on the Partnership's purchase money notes was $275,065 and $430,303 for the three months ended March 31, 2000 and 1999, respectively. The accrued interest payable on the purchase money notes of $22,649,942 and $22,374,877 as of March 31, 2000 and December 31, 1999, 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 agreements. 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 three months ended March 31, 2000 and 1999, the receipt of distributions from Local Partnerships was adequate to support operating cash requirements. Cash and cash equivalents decreased during the three month period ended March 31, 2000, as the distribution to Additional Limited Partners, made in January 2000 out of the proceeds of the 1999 sale of Wexford Ridge, exceeded cash flow distributions received from partnerships during the period. Results of Operations --------------------- The Partnership's net income for the three month period ended March 31, 2000 decreased from the corresponding period in 1999 primarily due to a decrease in share of income from partnerships resulting from the refinancing of the first mortgage loan on Rolling Green at Fall River in 1999, and also due to extraordinary gain from extinguishment of debt resulting from the discounted payoffs of the Four Winds West and Troy Manor purchase money notes in 1999. Offsetting the decrease in net income were an increase in interest income due to higher cash and cash equivalent balances during 2000 as a result of the receipt of proceeds from the sale of Wexford Ridge, a decrease in interest expense due to lower purchase money note balances during 2000 as a result of payments and extinguishments during 1999, and a decrease in general and administrative expenses primarily due to lower reimbursed payroll costs. For financial reporting purposes, the Partnership, as a limited partner in the Local Partnerships, does not record losses from the Local Partnerships in -24- PART I. FINANCIAL INFORMATION --------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS - Continued ----------------------------------- 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 recognized losses included in share of income from partnerships for the three month period ended March 31, 2000 did not include losses of $470,980, compared to excluded losses of $423,222 for the three month period ended March 31, 1999. No other significant changes in the Partnership's operations have taken place during this period. PART II. OTHER 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 purchase money notes. ITEM 5. OTHER INFORMATION ----------------- On April 2, 2000, Peachtree Partners (Peachtree) initiated an unregistered tender offer to purchase approximately 2,450 of the outstanding units of additional limited partnership interests (Units) in the Partnership at a price of $50 per Unit; the offer expires May 19, 2000. Peachtree is unaffiliated with 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. There is no established market for the purchase and sale of Units in the Partnership, although various informal secondary market services exist in addition to the current tender offer by Peachtree. Due to the limited markets, however, investors may be unable to sell or otherwise dispose of their Units in the Partnership. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- a. None b. No Reports on Form 8-K were filed with the Commission during the quarter ended March 31, 2000. All other items are not applicable. -25- 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 May 10, 2000 by: /s/ Michael J. Tuszka - ----------------- --------------------------------------- DATE Michael J. Tuszka Vice President and Chief Accounting Officer (Principal Financial Officer and Principal Accounting Officer) -26- EXHIBIT INDEX ------------- Exhibit Method of Filing - ------- ----------------------------- 27 Financial Data Schedule Filed herewith electronically -27-