UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THEx SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1996 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-20164 Krupp Government Income Trust II Massachusetts 04-3073045 (State or other jurisdiction of (IRS employer incorporation or organization) identification no.) 470 Atlantic Avenue, Boston, Massachusetts 02210 (Address of principal executive offices) (Zip Code) (617) 423-2233 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Part I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS KRUPP GOVERNMENT INCOME TRUST II BALANCE SHEETS ASSETS March 31, December 31, 1996 1995 Participating Insured Mortgage Investments ("PIMIs")(Note 2): Insured mortgages $150,421,994 $150,448,995 Additional loans 29,952,351 29,952,351 Participating Insured Mortgages ("PIMs") (Note 2) 46,932,699 45,436,663 Mortgage-Backed Securities ("MBS") (Note 3) 45,165,959 48,851,858 Total mortgage investments 272,473,003 274,689,867 Cash and cash equivalents 11,375,426 11,675,494 Prepaid acquisition fees and expenses, net of accumulated amortization of $3,319,663 and $2,922,496, repectively 13,163,979 13,561,146 Prepaid participation servicing fees, net of accumulated amortization of $877,497 and $761,220, repectively 4,617,050 4,733,327 Interest receivable and other assets 2,066,384 2,305,349 Total assets $303,695,842 $306,965,183 LIABILITIES AND SHAREHOLDERS' EQUITY Deferred income on Additional Loans (Note 5) $ 1,304,338 1,026,622 Other liabilities 8,384 20,576 Total liabilities 1,312,722 1,047,198 Commitments (Note 2) Shareholders' equity (Note 4): Common stock, no par value; 25,000,000 Shares authorized; 18,371,477 Shares issued and outstanding 302,764,362 304,530,460 Unrealized gain (loss) on MBS (381,242) 1,387,525 Total Shareholders' equity 302,383,120 305,917,985 Total liabilities and Shareholders' equity $303,695,842 $306,965,183 The accompanying notes are an integral part of the financial statements. KRUPP GOVERNMENT INCOME TRUST II STATEMENTS OF INCOME For the Three Months Ended March 31, 1996 1995 Revenue: Interest income - PIMs and PIMIs: Base interest $3,494,617 $2,749,292 Additional loan interest 380,495 409,035 Participation interest 379,237 277,123 Interest income - MBS 833,100 1,613,363 Interest income - other 146,941 210,705 Total revenue 5,234,390 5,259,518 Expenses: Asset management fee to an affiliate 517,116 534,266 Expense reimbursements to affiliates 122,478 127,394 Amortization of prepaid fees and expenses, and organization costs 515,944 421,831 General and administrative 103,849 96,948 Loss on sale of MBS - 1,400,000 Total expenses 1,259,387 2,580,439 Net income $3,975,003 $2,679,079 Earnings per Share $ .22 $ .15 Weighted average Shares outstanding 18,371,477 18,371,477 The accompanying notes are an integral part of the financial statements. KRUPP GOVERNMENT INCOME TRUST II STATEMENTS OF CASH FLOWS For The Three Months Ended March 31, 1996 1995 Operating activities: Net income $ 3,975,003 $ 2,679,079 Adjustments to reconcile net income to net cash provided by operating activities: Loss on sale of MBS - 1,400,000 Premium amortization 41,866 80,076 Amortization of prepaid fees and expenses and organization costs 515,944 421,831 Changes in assets and liabilities: Decrease in interest receivable and other assets 236,465 527,655 Decrease in other liabilities (12,192) (3,045) Net cash provided by operating activities 4,757,086 5,105,596 Investing activities: Investment in PIMs and insured mortgages (1,850,779) (15,147,846) Investment in Additional Loans - (2,000,000) Principal collections on MBS 1,875,266 3,120,773 Principal collections on PIMs 381,744 295,973 Increase in deferred income on Additional Loans 277,716 268,365 Net cash provided by (used for) investing activities 683,947 (13,462,735) Financing activity: Dividends (5,741,101) (5,741,101) Net decrease in cash and cash equivalents (300,068) (14,098,240) Cash and cash equivalents, beginning of period 11,675,494 19,649,192 Cash and cash equivalents, end of period $11,375,426 $ 5,550,952 The accompanying notes are an integral part of the financial statements. KRUPP GOVERNMENT INCOME TRUST II NOTES TO FINANCIAL STATEMENTS 1. Accounting Policies Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in this report on Form 10-Q pursuant to the Rules and Regulations of the Securities and Exchange Commission. However, in the opinion of Berkshire Mortgage Advisors Limited Partnership (the "Advisor"), the Advisor to Krupp Government Income Trust II (the "Trust"), the disclosures contained in this report are adequate to make the information presented not misleading. See Notes to Financial Statements in the Trust's Form 10-K for the year ended December 31, 1995 for additional information relevant to significant accounting policies followed by the Trust. In the opinion of the Advisor of the Trust, the accompanying unaudited financial statements reflect all adjustments (consisting primarily of normal recurring accruals) necessary to present fairly the Trust's financial position as of March 31, 1996 and the results of its operations and its cash flows for the three months ended March 31, 1996 and 1995. The results of operations for the three months ended March 31, 1996 are not necessarily indicative of the results which may be expected for the full year. See Management's Discussion and Analysis of Financial Condition and Results of Operations included in this report. 2. PIMs and PIMIs At March 31, 1996, the Trust has commitments to fund approximately $4,631,000 on its closed PIMs and PIMIs. These commitments will be funded by cash on hand and future principal collections from the MBS, PIMs and PIMIs. At March 31, 1996, the Partnership s PIMs and PIMIs have a fair value of approximately $218,617,000 and gross unrealized losses of approximately $8,690,000. The PIMs and PIMIs have maturities ranging from 2008 to 2036. 3. MBS At March 31, 1996, the Trust's MBS portfolio has an amortized cost of approximately $45,547,000 and gross unrealized gains and losses of approximately $329,000 and $710,000. The MBS portfolio has maturities ranging from 2008 to 2023. KRUPP GOVERNMENT INCOME TRUST II NOTES TO FINANCIAL STATEMENTS, Continued 4. Changes in Shareholder's Equity A summary of changes in Shareholders' equity for the three months ended March 31, 1996 is as follows: Total Common Retained Unrealized Shareholders' Stock Earnings Gain(Loss) Equity Balance at December 31, 1995 $304,530,460 $ - $ 1,387,525 $305,917,985 Net income - 3,975,003 - 3,975,003 Dividends (1,766,098) (3,975,003) - (5,741,101) Decrease in unrealized gain on MBS - - (1,768,767) (1,768,767) Balance at March 31, 1996 $302,764,362 $ - $ (381,242) $302,383,120 5. Related Party Transactions During the three months ended March 31, 1996 and 1995, the Trust earned $147,761 and $147,761, respectively, of interest on an Additional Loan with affiliates of the Advisor. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources The most significant demand on the Trust's liquidity are quarterly dividends paid to investors of approximately $5.7 million. Funds used for dividends come from interest received on the PIMs, PIMIs, MBS, cash and cash equivalents net of operating expenses, and certain principal collections received on the PIMs and MBS. The Trust funds a portion of the dividends from principal collections, as a result, the capital resources of the Trust will continually decrease. As the capital resources decrease, the total cash inflows to the Trust will also decrease which will result in periodic adjustments to the quarterly dividends paid to investors. In addition to funding its quarterly dividends paid to investors the Trust has commitments to fund $4,631,000 on its PIMs and PIMIs. These commitments will be funded by cash on hand and future principal collections from the MBS, PIMs and PIMIs. If total cash inflows decrease, the Trust may need to make periodic adjustments to dividends paid to the investors in order to maintain sufficient liquidity. The Advisor of the Trust periodically reviews the dividend rate to determine whether an adjustment to the dividend rate is necessary based on projected future cash flows. Based on current projections, the Advisor believes the Trust can maintain the current dividend rate for the foreseeable future. In general, the Advisor tries to set a dividend rate that provides for level quarterly distributions of cash available for distribution. To the extent quarterly dividends do not fully utilize the cash available for distribution and cash balances increase, the Advisor may adjust the dividend rate or distribute such funds through a special distribution. For the first five years of the PIMs and PIMIs the borrowers are prohibited from repaying. For the second five years, the borrowers can repay the loans incurring a prepayment penalty for PIMs or paying all amounts due under the PIMIs and satisfying the required preferred return. The Trust has the option to call certain PIMs and all the PIMIs by accelerating their maturity if the loans are not prepaid by the tenth year after permanent funding. The Trust will determine the merits of exercising the call option for each PIM or PIMI as economic conditions warrant. Such factors as the condition of the asset, local market conditions, interest rates and available financing will have an impact on this decision. (Amounts in thousands, except per Share amounts) Three Months Inception Ended Through 3/31/96 3/31/96 Distributable Cash Flow (a): Net income $ 3,975 $ 56,381 Items providing or not requiring the use of operating funds: Loss on sale of MBS - 1,379 Amortization of prepaid fees and expenses and organization costs 516 4,242 Additional loan interest and deferred 278 1,305 Total Distributable Cash Flow ("DCF") $ 4,769 $ 63,307 DCF per Share based on Shares outstanding at March 31, 1996 $ .26 $ 3.45 (c) Dividends: Total dividends to Shareholders $ 5,741 (b) $101,162 (b) Average dividend per Share based on Shares outstanding at March 31, 1996 $ .32 (b) $ 5.51 (b)(c) (a) Distributable Cash Flow consists of income before amortization of prepaid fees and expenses and organization costs and before the effect of any gains or losses from the sale of assets and includes interest collections on Additional Loans. (b) Includes an estimate of the May 1996 distribution. (c) Shareholders average per Share return of capital as of May 1996 is $2.06 [$5.51 - $3.45]. Return of capital represents that portion of dividends which is not funded from DCF, such as proceeds from the sale of assets and substantially all of the principal collections received from MBS and PIMs. Assessment of Credit Risk The Partnership's investments in mortgages are guaranteed or insured by the Federal National Mortgage Association ( FNMA ), the Federal Home Loan Mortgage Corporation ( FHLMC ), the Government National Mortgage Association ( GNMA ) and the United States Department of Housing and Urban Development ( HUD ) and therefore the certainty of their cash flows and the risk of material loss of the amounts invested depends on the creditworthiness of these entities. FNMA is a federally chartered private corporation that guarantees obligations originated under its programs. However, obligations of FNMA are not backed by the U.S. Government. FNMA is one of the largest corporations in the United States and the Secretary of the Treasury of the United States has discretionary authority to lend up to $2.25 billion to FNMA at any time. FHLMC is a federally chartered corporation that guarantees obligations originated under its programs and is wholly-owned by the twelve Federal Home Loan Banks. These obligations are not guaranteed by the U.S. Government or the Federal Home Loan Bank Board. HUD, an agency of the U.S. Government, insures the obligations originated under its programs which are backed by the full faith and credit of the U.S. Government. The Trust's Additional Loans have similar risks as those associated with higher risk debt instruments, including: reliance on the owner's operating skills and ability to maintain occupancy levels, control operating expenses, maintain properties and obtain adequate insurance coverage; adverse changes in general economic conditions, adverse local conditions, and changes in governmental regulations, real estate zoning laws, or tax laws; and other circumstances over which the Trust may have little or no control. Operations The following discussion relates to the operations of the Trust during the three months ended March 31, 1996 and 1995. (Amounts in thousands, except per Share amounts): Three Months Ended March 31, 1996 1995 Amount Per Share Amount Per Share Interest income on PIMs and PIMIs: Base interest $3,495 $.19 $2,749 $.15 Additional loan interest received including amounts deferred 658 .03 677 .04 Participation interest 379 .02 277 .01 Interest income on MBS 833 .05 1,613 .09 Interest income - other 147 .01 211 .01 Trust expenses (743) (.04) (758) (.04) DCF 4,769 .26 4,769 .26 Reconciliation to net income: Loss on sale of MBS - - (1,400) (.08) Additional loan interest deferred (278) (.02) (268) (.01) Amortization of prepaid fees and expenses and organization costs (516) (.02) (422) (.02) Net income $3,975 .22 $2,679 .15 Weight Average Shares Outstanding 18,371,477 18,371,477 The Trust's net income increased $1,296,000 during the first quarter of 1996 as compared to the first quarter of 1995 primarily because the Trust recognized a $1,400,000 loss on the sale of MBS in the first quarter of 1995. In April 1995, the Trust sold approximately $40 million of MBS and used the proceeds to fund the acquisition of PIMs and PIMIs. Interest income on MBS decreased $780,000 during the first quarter of 1996 versus the first quarter of 1995 due primarily to the sale of MBS. The Trust invested approximately $52.6 million in PIMs and PIMIs in 1995 having base interest rates ranging from 6.875% to 7.875% per annum, which increased base interest income on PIMs and PIMIs by $746,000 during the first three months of 1996 as compared to the first three months of 1995. Overall, total revenue did not change materially between the first quarter of 1996 and first quarter of 1995. The Trust experienced a $102,000 increase in participation interest income during the first three months of 1996 versus the corresponding period in 1995. Amortization of prepaid fees and expenses increased $94,000 in the first quarter of 1996 as compared to the first quarter of 1995, because the Trust began amortizing prepaid fees and expenses on newly acquired PIMs and PIMIs. KRUPP GOVERNMENT INCOME TRUST II PART II - OTHER INFORMATION Item 1. Legal Proceedings Response: None Item 2. Changes in Securities Response: None Item 3. Defaults upon Senior Securities Response: None Item 4. Submission of Matters to a Vote of Security Holders Response: None Item 5. Other Information Response: None Item 6. Exhibits and Reports on Form 8-K Response: None SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Krupp Government Income Trust II (Registrant) BY: /s/Robert A. Barrows Robert A. Barrows Treasurer and Chief Accounting Officer of Krupp Government Income Trust II. DATE: April 24, 1996