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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
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 0-19244
Krupp Government Income Trust
(Exact name of registrant as specified in its charter)
Massachusetts 04-3089272
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
One Beacon Street, Boston, Massachusetts 02108
(Address of principal executive offices) (Zip Code)
(617) 523-0066
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
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 |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
SEC 1296 (08-03) Potential persons who are to respond to the collection of
information contained in this form are not required to respond
unless the form displays a currently valid OMB control number.
-1-
Part I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
This Form 10-Q contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. When used in this Form 10-Q, the words "believes," "anticipates,"
"expects," "plans," "intends," "estimates," "continue," "may" or "will" (or the
negative of such words) and similar expressions are intended to identify
forward-looking statements. Such statements are subject to a number of risks and
uncertainties, including but not limited to the following: federal, state or
local regulations; adverse changes in general economic or local conditions;
pre-payments of mortgages; failure of borrowers to pay participation interests
due to poor operating results of properties underlying the mortgages; uninsured
losses and potential conflicts of interest between the Trust and its Affiliates,
including the Trustees. The Company's filings with the Securities and Exchange
Commission, including its Annual Report on Form 10-K for the year ended December
31, 2002, contain additional information concerning such risk factors. Actual
results in the future could differ materially from those described in any
forward-looking statements as a result of the risk factors set forth above, and
the risk factors described in the Annual Report.
-2-
KRUPP GOVERNMENT INCOME TRUST
BALANCE SHEETS
----------
ASSETS
September 30, December 31,
2003 2002
------------- ------------
Participating Insured Mortgage Investments
("PIMIs") (Note 2):
Insured Mortgages $ 9,098,732 $32,255,154
Additional Loans, net of impairment provision
of $1,032,617 and $1,032,272, respectively 367,383 4,537,719
Participating Insured Mortgages ("PIMs") (Note 2) -- 16,949,637
Mortgage-Backed Securities and insured mortgage loan ("MBS") (Note 3) 2,007,482 6,313,121
----------- -----------
Total mortgage investments 11,473,597 60,055,631
Cash and cash equivalents 1,537,592 1,986,243
Interest receivable and other assets 76,293 370,542
Prepaid acquisition fees and expenses, net
of accumulated amortization of $738,546 -- 46,160
Prepaid participation servicing fees, net of
accumulated amortization of $683,812 -- 62,497
----------- -----------
Total assets $13,087,482 $62,521,073
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred income on Additional Loans $ 367,383 $ 1,351,768
Other liabilities 39,208 48,938
----------- -----------
Total liabilities 406,591 1,400,706
----------- -----------
Shareholders' equity (Note 4):
Common stock, no par value; 17,510,000
Shares authorized; 15,053,135 Shares issued and outstanding 12,516,459 60,668,605
Accumulated comprehensive income 164,432 451,762
----------- -----------
Total Shareholders' equity 12,680,891 61,120,367
----------- -----------
Total liabilities and Shareholders' equity $13,087,482 $62,521,073
=========== ===========
The accompanying notes are an integral
part of the financial statements.
-3-
KRUPP GOVERNMENT INCOME TRUST
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
----------
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------------- -----------------------------
2003 2002 2003 2002
--------- ---------- ----------- -----------
Revenues:
Interest income - PIMs and PIMIs:
Basic interest $ 156,481 $ 955,937 $ 1,942,585 $ 3,576,455
Additional Loan interest (Note 2) -- 80,090 1,954,960 240,272
Participation interest (Note 2) -- -- 1,794,493 1,964,251
Interest income - MBS 201,293 380,510 420,757 1,124,224
Interest income - cash and cash equivalents 16,724 44,047 111,798 134,616
--------- ---------- ----------- -----------
Total revenues 374,498 1,460,584 6,224,593 7,039,818
--------- ---------- ----------- -----------
Expenses:
Asset management fee to an affiliate 23,450 119,057 162,413 446,682
Expense reimbursements to affiliates 57,999 55,377 213,675 147,565
Amortization of prepaid fees and expenses 15,899 95,679 108,657 620,629
General and administrative 92,501 133,780 302,830 353,073
--------- ---------- ----------- -----------
Total expenses 189,849 403,893 787,575 1,567,949
--------- ---------- ----------- -----------
Net income 184,649 1,056,691 5,437,018 5,471,869
Other comprehensive income:
Net change in unrealized gain on MBS (60,700) 43,027 (287,330) (139,203)
--------- ---------- ----------- -----------
Total comprehensive income $ 123,949 $1,099,718 $ 5,149,688 $ 5,332,666
========= ========== =========== ===========
Basic earnings per Share $ .01 $ .07 $ .36 $ .36
========= ========== =========== ===========
Weighted average Shares outstanding 15,053,135 15,053,135
========== ==========
The accompanying notes are an integral
part of the financial statements.
-4-
KRUPP GOVERNMENT INCOME TRUST
STATEMENTS OF CASH FLOWS
----------
For the Nine Months
Ended September 30,
-------------------------------
2003 2002
------------ ------------
Operating activities:
Net income $ 5,437,018 $ 5,471,869
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of discounts (32,788) (174,940)
Amortization of prepaid fees and expenses 108,657 620,629
Changes in assets and liabilities:
Decrease in interest receivable and other assets 294,249 374,913
Decrease in deferred income on Additional Loans (984,385) (240,272)
Decrease in other liabilities (9,730) (809)
------------ ------------
Net cash provided by operating activities 4,813,021 6,051,390
------------ ------------
Investing activities:
Principal collections on MBS 4,051,097 8,364,163
Principal collections on Additional Loans 4,170,336 --
Principal collections on PIMs and Insured Mortgages 40,106,059 47,933,263
------------ ------------
Net cash provided by investing activities 48,327,492 56,297,426
------------ ------------
Financing activity:
Dividends (53,589,164) (72,405,580)
------------ ------------
Net decrease in cash and cash equivalents (448,651) (10,056,764)
Cash and cash equivalents, beginning of period 1,986,243 13,154,231
------------ ------------
Cash and cash equivalents, end of period $ 1,537,592 $ 3,097,467
============ ============
Non cash activities:
Decrease in unrealized gain on MBS $ (287,330) $ (139,203)
============ ============
The accompanying notes are an integral
part of the financial statements.
-5-
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS
----------
1. Accounting Policies
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America 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"), which is
the advisor to Krupp Government Income Trust (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, 2002 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 of only normal
recurring accruals) necessary to present fairly the Trust's financial
position as of September 30, 2003, its results of 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 three and nine months ended September
30, 2003 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 September 30, 2003, the Trust's remaining PIMI had a fair value of
$9,098,732. Fair value of the FHA insured first mortgage is based on MBS
with similar interest rates or on expected payoff proceeds. Fair value
includes the estimated collection value of the Additional Loan. Fair value
does not include any value for the participation features. The remaining
PIMI matures in 2034. At September 30, 2003, the remaining PIMI was not
delinquent of principal or interest.
The Mountain View Additional Loan was scheduled to mature in September
2003. When the Trust entered into the second workout agreement in June
1999, it was the Trust's intention to extend the maturity date of the
Additional Loan to coincide with the expiration date of the interest
rebate in December of 2004. While reviewing the existing Additional Loan
Agreement, the Advisor noted that the maturity date of the Additional Loan
was not updated at the time of the second workout agreement. On September
8, 2003, the Advisor entered into a third modification with the borrower
to extend the maturity date to December 31, 2004 to correct this
oversight.
Mountain View has been adversely affected by the competitive rental
housing market. Based on the Advisor's analysis of market conditions and
property operations and their effect on the property's value, the Trust
maintains a valuation allowance of $1,032,617 for Mountain View. Between
the valuation allowance and the related deferred income on Additional
Loans liability account, the Mountain View additional loan has been
effectively fully reserved.
On May 30, 2003, the Trust received a prepayment of the Windward Lakes
Apartments Subordinated Promissory Note and the Windward Lakes Apartments
Additional Loan. The Trust received $2,471,294 of Additional Loan
principal, $970,575 of Additional Loan interest, $719,682 of Shared
Appreciation Interest and $684,291 of accrued interest from the workout
agreement that expired in 2000. On June 16, 2003, the Trust received
$13,301,440 in principal proceeds on the first mortgage note. In addition,
the Trust recognized $373,757 of Additional Loan interest that had been
previously received and recorded as deferred income on the Additional
Loan. On July 24, 2003, the Trust paid a special dividend of $1.22 per
share from the proceeds of the Windward Lakes prepayment.
On March 27, 2003, the Trust received a prepayment of the Rivergreens
Apartments Subordinated Promissory Note. The Trust received $547,978 of
Shared Appreciation Interest and $383,297 of Minimum Additional Interest.
On April 10, 2003, the Trust received $9,500,670 representing the
principal proceeds on the first mortgage loan from the Rivergreens
Apartments PIM. On May 9, 2003, the Trust paid a special dividend of $0.70
per share from the proceeds of the Rivergreens Apartments PIM prepayment.
Continued
-6-
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS, Continued
----------
2. PIMs and PIMIs, continued
On March 12, 2003, the Trust sold the Lifestyles Ginnie Mae MBS at par of
$9,746,038 to the borrower of the Lifestyles PIMI. Concurrently, the
borrower paid off the full amount due on the Additional Loan of
$1,817,665. In addition, the Trust recognized $343,659 of Additional Loan
interest previously received and recorded as deferred income on the
Additional Loan. On May 7, 2003, the Trust paid a special dividend of
$0.77 per share from the proceeds of the Lifestyles Apartments PIMI.
On January 21, 2003, the Trust received a prepayment of the Mill Pond I
PIM of $7,430,727 representing the principal proceeds on the first
mortgage. The underlying property value did not increase sufficiently to
meet the criteria for the Trust to earn any participating interest. On May
5, 2003, the Trust paid a special dividend of $0.50 per share from the
proceeds of the Mill Pond I PIM.
3. MBS
At September 30, 2003, the Trust's MBS portfolio had an amortized cost of
$1,843,050 and unrealized gains of $164,432. The portfolio has maturities
ranging from 2008 to 2023.
On July 15, 2003, the Trust received a prepayment of the Pointe East
Apartments insured mortgage for $3,251,119. The Trust also received a
prepayment premium of $130,045 from this payoff. On August 4, 2003, the
Trust paid a special dividend of $0.23 per share from the proceeds of the
Pointe East Apartments insured mortgage payoff.
4. Changes in Shareholders' Equity
A summary of changes in Shareholder's equity for the nine months ended
September 30, 2003 is as follows:
Total Accumulated
Common Retained Comprehensive Shareholders'
Stock Earnings Income Equity
------------ ----------- ------------- -------------
Balance at December 31, 2002 $ 60,668,605 $ -- $ 451,762 $ 61,120,367
Net income -- 5,437,018 -- 5,437,018
Dividends (48,152,146) (5,437,018) -- (53,589,164)
Change in unrealized gain on MBS -- -- (287,330) (287,330)
------------ ----------- --------- ------------
Balance at September 30, 2003 $ 12,516,459 $ -- $ 164,432 $ 12,680,891
============ =========== ========= ============
-7-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
financial statements and accompanying notes contained in the Trust's 2002 Annual
Report on Form 10-K and in this report on Form 10-Q.
Certain statements in this Management's Discussion and Analysis of Financial
Condition and Results of Operations and elsewhere in this report on Form 10-Q
constitute "forward-looking statements" within the meaning of the Federal
Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve known and unknown risks, uncertainties and other factors
which may cause the Trust's actual results, performance or achievements to be
materially different from any future results, performance or achievements
expressed or implied by these forward-looking statements. These factors include,
among other things, federal, state or local regulations; adverse changes in
general economic or local conditions; the inability of the borrower to meet
financial obligations on additional loans; pre-payments of mortgages; failure of
borrowers to pay participation interests due to poor operating results at
properties underlying the mortgages; uninsured losses and potential conflicts of
interest between the Trust and its Affiliates, including the Advisor.
Liquidity and Capital Resources
At September 30, 2003, the Trust had liquidity consisting of cash and cash
equivalents of approximately $1.5 million as well as the cash inflows provided
by the remaining PIMI, MBS and cash and cash equivalents. The Trust may also
receive additional cash flow from the participation features of its remaining
PIMI. The Trust anticipates that these sources will be adequate to provide the
Trust with sufficient liquidity to meet its obligations, including providing
dividends to its investors.
The most significant demands on the Trust's liquidity are quarterly dividends
paid to investors of approximately $300,000 and special dividends. Funds for
dividends come from interest income received on the remaining PIMI, MBS and cash
and cash equivalents net of operating expenses, and the principal collections
received on the remaining PIMI and MBS. The portion of dividends funded from
principal collections and cash reserves reduces the capital resources of the
Trust. As the capital resources of the Trust decrease, the total cash flows to
the Trust will also decrease, which may result in periodic adjustments to the
dividends paid to the investors.
The Advisor periodically reviews the dividend rate to determine whether an
adjustment is necessary based on projected future cash flows. The current
dividend rate is $0.02 per share per quarter. The Trustees, based on the
Advisor's recommendations, generally set a dividend rate that provides for level
quarterly dividends. To the extent quarterly dividends do not fully utilize the
cash available for distribution and cash balances increase, the Advisor may
adjust the dividend rate or distribute such funds through a special dividend.
In addition to providing guaranteed or insured monthly principal and interest
payments from the insured first mortgage, the Trust's investment in the
remaining PIMI also may provide additional income through the interest on the
Additional Loan portion of the PIMI as well as participation interest based on
operating cash flow and an increase in the value realized upon the sale or
refinance of the underlying property. However, collection of the Additional Loan
principal and interest from the participation feature are neither guaranteed nor
insured and depend upon the successful operations of the underlying property.
On July 15, 2003, the Trust received a prepayment of the Pointe East Apartments
insured mortgage for $3,251,119. The Trust also received a prepayment premium of
$130,045 from this payoff. On August 4, 2003, the Trust paid a special dividend
of $0.23 per share from the proceeds of the Pointe East Apartments insured
mortgage payoff.
On May 30, 2003, the Trust received a prepayment of the Windward Lakes
Apartments Subordinated Promissory Note and the Windward Lakes Apartments
Additional Loan. The Trust received $2,471,294 of Additional Loan principal,
$970,575 of Additional Loan interest, $719,682 of Shared Appreciation Interest
and $684,291 of accrued interest from the workout agreement that expired in
2000. On June 16, 2003, the Trust received $13,301,440 in principal proceeds on
the first mortgage note. In addition, the Trust recognized $373,757 of
Additional Loan interest that had been previously received and recorded as
deferred income on the Additional Loan. On July 24, 2003, the Trust paid a
special dividend of $1.22 per share from the proceeds of the Windward Lakes
prepayment.
On March 27, 2003, the Trust received a prepayment of the Rivergreens Apartments
Subordinated Promissory Note. The Trust received $547,978 of Shared Appreciation
Interest and $383,297 of Minimum Additional Interest. On April 10, 2003, the
Trust received $9,500,670 representing the principal proceeds on the first
mortgage loan from the Rivergreens Apartments PIM. On May 9, 2003, the Trust
paid a special dividend of $0.70 per share from the proceeds of the Rivergreens
Apartments PIM prepayment.
-8-
On March 12, 2003, the Trust sold the Lifestyles Ginnie Mae MBS at par of
$9,746,038 to the borrower of the Lifestyles PIMI. Concurrently, the borrower
paid off the full amount due on the Additional Loan of $1,817,665. In addition,
the Trust recognized $343,659 of Additional Loan interest previously received
and recorded as deferred income on the Additional Loan. On May 7, 2003, the
Trust paid a special dividend of $0.77 per share from the proceeds of the
Lifestyles Apartments PIMI.
On January 21, 2003, the Trust received a prepayment of the Mill Pond I PIM of
$7,430,727 representing the principal proceeds on the first mortgage. The
underlying property value did not increase sufficiently to meet the criteria for
the Trust to earn any participating interest. On May 5, 2003, the Trust paid a
special dividend of $0.50 per share from the proceeds of the Mill Pond I PIM.
The remaining PIMI investment, Mountain View, operates under a workout agreement
with the Trust. The Mountain View agreement modifies the borrower's obligation
to make Additional Loan interest payments, regardless of whether the property
generates sufficient revenues to do so, to an obligation to pay Additional Loan
interest only if the property generates Surplus Cash, as defined by HUD. The
Trust did not receive any Additional Loan interest or Surplus Cash payments from
its remaining PIMI during the first nine months of 2003. For the underlying
property's fiscal year ending December 31, 2002, Mountain View did not generate
any Surplus Cash.
Mountain View has experienced problems due to competitive market conditions. In
June 1999, the Trust approved a second workout of Mountain View. Under its
terms, the Trust agreed to reduce the effective interest rate on the insured
first mortgage by 1.25% retroactively for 1999 and each year thereafter through
2004, and to change the loan's participation terms. The workout eliminated the
preferred return feature, forgave $288,580 of previous accruals of Additional
Loan interest related to the first workout, and changed the Trust's
participation in Surplus Cash generated by the property and its application
towards Additional Loan interest. The Trust will receive 75% of the first
$130,667 of Surplus Cash and 50% of any remaining Surplus Cash on an annual
basis to pay Additional Loan interest. Unpaid Additional Loan interest related
to the second workout will accrue and be payable if there are sufficient
proceeds from a sale or refinancing of the property. In addition, the borrower
repaid $153,600 of the Additional Loan and funded approximately $54,000 to a
reserve for property improvements.
The Mountain View Additional Loan was scheduled to mature in September 2003.
When the trust entered into the second workout agreement in June 1999, it was
the Trust's intention to extend the maturity date of the Additional Loan to
coincide with the expiration date of the interest rebate in December of 2004.
While reviewing the existing Additional Loan Agreement, the Advisor noted that
the maturity date of the Additional Loan was not updated at the time of the
second workout agreement. On September 8, 2003, the Advisor entered into a third
modification with the borrower to extend the maturity date to December 31, 2004
to correct this oversight.
Under the restructuring described above, management determined that the new
interest rate level of the loan was at or above the then prevailing rate for
similar instruments and therefore did not meet the criteria for a troubled debt
restructuring. Accordingly, the restructuring and new rate was accounted for
prospectively and not as a troubled debt restructuring.
During 2002, operating results at Mountain View deteriorated. This trend has
continued through 2003. A building with 20 three-bedroom apartments was out of
service for 18 months as a result of a fire in 2001. Reconstruction work
necessitated by the fire was completed in mid-2002, with insurance proceeds
covering the total cost of the restoration and a portion of the rental income.
Additionally, occupancy in the remaining units has been affected by local
economic conditions. These factors have made the rental market much more
competitive for apartment owners, and the use of concessions to attract
potential renters has increased throughout the market. Consequently, rental
income was down in 2002 and is not expected to improve in 2003. At the same
time, both insurance costs and real estate taxes have increased dramatically,
further deteriorating operating results. As a result of the factors described
above, the Trust maintains a valuation allowance for Mountain View of
$1,032,617. Between the valuation allowance and the related deferred income on
Additional Loans liability account, the Mountain View additional loan has been
effectively fully reserved.
Whether the operating performance of Mountain View provides sufficient cash flow
from operations to pay either the Additional Loan principal and interest or
participation income will depend on factors that the Trust has little or no
control over. Should the property be unable to generate sufficient cash flow to
pay the Additional Loan interest, it would reduce the Trust's distributable cash
flow and could affect the value of the Additional Loan collateral.
There are no contractual restrictions on the repayment of the remaining PIMI.
The participation feature and Additional Loan are neither insured nor
guaranteed. If the prepayment of the PIMI results from the foreclosure on the
underlying property or an insurance claim, the Trust would probably not receive
any participation income or any amounts due under the Additional Loan.
-9-
The Trust has the option to call the remaining PIMI by accelerating the maturity
if the loan is not prepaid by the tenth year after permanent funding. If the
call feature is exercised then the insurance feature of the loan would be
canceled. Therefore, the Advisor will determine the merits of exercising the
call option for the remaining PIMI as economic conditions warrant. Such factors
as the condition of the asset, local market conditions, the interest rate
environment and available financing will have an impact on these decisions.
Critical Accounting Policies
The Trust's critical accounting policies relate to revenue recognition related
to the Trust's remaining PIMI investment, impaired mortgage loan, amortization
of Prepaid Fees and Expenses and the carrying value of its MBS. The Trust's
policies are as follows:
The Trust accounted for its MBS portion of a PIM or PIMI investment in
accordance with the Financial Accounting Standards Board's Statement 115,
"Accounting for Certain Investments in Debt and Equity Securities" ("FAS 115"),
under the classification of held to maturity as these investments have a
participation feature. As a result, the Trust would not sell or otherwise
dispose of the MBS. Accordingly, the Trust had both the intention and ability to
hold these investments to expected maturity. The Trust carried these MBS at
amortized cost. The insured mortgage portion of the FHA PIM or FHA PIMI is
carried at amortized cost. The Trust holds these mortgages at amortized cost
since they are fully insured by FHA. The Additional Loans are carried at
amortized cost unless the Advisor of the Trust believes there is an impairment
in value, in which case a valuation allowance is established in accordance with
FAS 114 "Accounting by Creditors for Impairment of a Loan" and FAS 118
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures". The Trust, in accordance with FAS 115, classifies its MBS
portfolio as available-for-sale. The Trust classifies its MBS portfolio as
available-for-sale as a portion of the MBS portfolio may remain after all of the
PIMs and PIMIs payoff and that it will be necessary to then sell the remaining
MBS portfolio at that time in order to close out the Trust. In addition, other
situations such as liquidity needs could arise which would necessitate the sale
of a portion of the MBS portfolio. As such, the Trust carries its MBS at fair
market value and reflects any unrealized gains (losses) as a separate component
of Shareholders' Equity. The Trust amortizes purchase premiums or discounts over
the life of the underlying mortgages using the effective interest method.
Basic interest is recognized based on the stated rate of the Department of
Housing and Urban Development ("HUD") Insured Mortgage loan (less the servicer's
fee) or the coupon rate of the Government National Mortgage Association ("GNMA")
MBS. The Trust recognizes interest related to the participation features when
the amount becomes fixed and the transaction that gives rise to such amount is
finalized, cash is received and all contingencies are resolved. This could be
the sale or refinancing of the underlying real estate, which results in a cash
payment to the Trust or a cash payment made to the Trust from surplus cash
relative to the participation feature. The Trust defers the recognition of
Additional Loan interest payments as income to the extent these interest
payments were from escrows established with the proceeds of the Additional Loan.
When the properties underlying the PIMI's generate sufficient cash flow to make
the required Additional Loan interest payments and the Additional Loan value is
deemed collectible, the Trust recognizes income as earned and commences
amortization of the deferred interest amounts into income over the remaining
estimated term of the Additional Loan. During periods where mortgage loans are
impaired the Trust suspends amortizing deferred interest.
The Trust also fully reserves the portion of any Additional Loan interest
payment satisfied through the issuance of an operating loan and any associated
interest due on such operating loan. The Trust will recognize the income related
to the operating loan when the borrower repays amounts due under the operating
loan.
Impaired loans are those Additional Loans which the Advisor believes that the
collection of all amounts due in accordance with the contractual terms of the
loan agreement are not likely. Impaired loans are measured based on the fair
value of the underlying collateral net of estimated selling costs. The Trust
measures impairment on these loans quarterly using the most current operating
information available. Interest received on the impaired loans is applied
against the loan principal.
Prepaid fees and expenses represent prepaid acquisition fees and expenses and
prepaid participation servicing fees paid for the acquisition and servicing of
PIMs and PIMIs. The Trust amortizes prepaid acquisition fees and expenses using
a method that approximates the effective interest method over a period of ten to
twelve years, which represents the estimated life of the underlying mortgage.
The Trust amortizes prepaid participation servicing fees using a method that
approximates the effective interest method over a ten year period beginning at
final endorsement of the loan if a HUD-insured mortgage loan or a GNMA MBS. Upon
the repayment of a PIM or PIMI any unamortized acquisition fees and expenses and
unamortized participation servicing fees related to such loan are expensed.
-10-
Results of Operations
Net income of the Trust decreased for the three months ending September 30, 2003
as compared to the same period ending September 30, 2002 primarily due to
decreases in basic interest income on PIMs and PIMIs, Additional Loan interest
and interest income on MBS. This decrease is partially offset by decreases in
asset management fees and amortization expense. Basic interest income on PIMs
and PIMIs decreased primarily due to the payoffs of the Rivergreens Apartments
PIM in April of 2003, the Mill Pond I PIM in January of 2003 and the payoffs of
the Windward Lakes and Lifestyles PIMIs in June and March of 2003, respectively.
Additional Loan interest decreased due to the payoff of the Windward Lakes
Additional Loan in May of 2003. Interest income on MBS decreased primarily due
to the payoff of the Pointe East Apartments MBS in July of 2003 and the Rosemont
Apartments MBS in August 2002. This decrease is partially offset by the
prepayment premium received from the Pointe East payoff. Asset management fees
decreased due to the decline in the Trust's asset base as a result of principal
collections and prepayments. Amortization expense decreased primarily due to the
Rivergreen Apartments PIM payoff in April of 2003 and the full amortization of
the remaining prepaid fees and expenses on the Windward Lakes PIMI and the Mill
Pond I Apartments PIM in 2002 and January of 2003, respectively.
Net income of the Trust decreased slightly for the nine months ending September
30, 2003 as compared to the same period ending September 30, 2002 primarily due
to decreases in basic interest income on PIMs and PIMIs, participation interest
and interest income on MBS and an increase in expense reimbursement to
affiliates. This decrease is partially offset by an increase in Additional Loan
interest and decreases in asset management fees and amortization expense. Basic
interest income on PIMs and PIMIs decreased due primarily to the payoffs of the
Rivergreen Apartments PIM in April of 2003, the Mill Pond I Apartments PIM in
January of 2003, the payoffs of the River View and Lincoln Green PIMs in 2002
and the payoffs of the Windward Lakes PIMI in June of 2003 and the Lifestyles
PIMI in March of 2003. The decrease in basic interest income on PIMs and PIMIs
was partially offset by accrued interest received from the Windward Lakes payoff
in relation to the workout agreement. Participation interest decreased due to
the collections from the Windward Lakes, Lifestyles and Rivergreen Apartments
payoffs in 2003 being less than the collections received from the Lincoln Green,
River View and Waterford payoffs in 2002. Interest income on MBS decreased
primarily due to the payoffs of the Rosemont Apartments and Parkwest Apartments
MBS in 2002 and on-going single-family MBS principal collections. The decrease
in interest income on MBS is partially offset by the prepayment premium received
from the Pointe East payoff. Expense reimbursement of affiliates increased due
to a change in the estimated cost of services provided to the Trust in 2002.
Additional Loan interest increased due to the collection of base interest and
the recognition of deferred revenue from the payoff of the Windward Lakes PIMI
in May of 2003 and the recognition of deferred revenue from the Lifestyles PIMI
payoff in March of 2003. Asset management fees decreased due to the decline in
the Trust's asset base as a result of principal collections and prepayments.
Amortization expense decreased due primarily to the River View, Waterford and
Lincoln Green PIM payoffs in 2002, the Rivergreen Apartments PIM payoff in April
of 2003 and the full recognition of prepaid fees and expenses for the Mill Pond
I PIM in January of 2003 and the Lifestyles and Windward Lakes PIMIs in 2002.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Assessment of Credit Risk
The Trust's investments in its remaining insured mortgage and MBS are guaranteed
and/or insured by Fannie Mae, the Federal Home Loan Mortgage Corporation
("FHLMC"), GNMA and HUD and therefore the certainty of their cash flows and the
risk of material loss of the amounts invested depends on the creditworthiness of
these entities.
Fannie Mae is a federally chartered private corporation that guarantees
obligations originated under its programs. FHLMC is a federally chartered
corporation that guarantees obligations originated under its programs. These
obligations are not guaranteed by the U.S. Government or the Federal Home Loan
Bank Board. However, Fannie Mae and FHLMC are two of the largest corporations in
the United States, and both have significant experience in mortgage
securitizations. In addition, their MBS carry the highest credit rating given to
financial instruments. GNMA guarantees the full and timely payment of principal
and basic interest on the securities it issues, which represents interest in
pooled mortgages insured by HUD. Obligations insured by HUD, an agency of the
U.S. Government, are backed by the full faith and credit of the U.S. Government.
Collection of the principal and interest of the Additional Loan and interest on
the participation features have risks similar to those associated with higher
risk debt instruments, including: reliance on the owner's operating skills,
ability to maintain occupancy levels, control operating expenses, ability to
maintain the properties and obtain adequate insurance coverage. Operations also
may be affected by adverse changes in general economic conditions, local
conditions, and
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changes in governmental regulations, real estate zoning laws, or tax laws; and
other circumstances over which the Trust may have little or no control.
The Trust's investments also include cash and cash equivalents of approximately
$1.1 million of Agency paper, which is issued by Government Sponsored
Enterprises with a credit rating equal to the top rating category of a
nationally recognized statistical rating organization.
Interest Rate Risk
The Trust's primary market risk exposure is to interest rate risk, which can be
defined as the exposure of the Trust's net income, comprehensive income or
financial condition to adverse movements in interest rates. At September 30,
2003, the Trust's remaining PIMI and MBS comprise the majority of the Trust's
assets. Decreases in interest rates may accelerate the prepayment of the Trust's
investments. Increases in interest rates may decrease the proceeds from a sale
of the MBS. The Trust does not utilize any derivatives or other instruments to
manage this risk as the Trust plans to hold its remaining PIMI investment to
expected maturity while it is expected that substantially all of the MBS will
prepay over the same time period thereby mitigating any potential interest rate
risk to the disposition value for any remaining MBS.
The Trust monitors prepayments and considers prepayment trends, as well as
dividend requirements of the Trust, when setting regular dividend policy. For
MBS, the fund forecasts prepayments based on trends in similar securities as
reported by statistical reporting entities such as Bloomberg. For its remaining
PIMI investment, the Trust incorporates prepayment assumptions into planning as
the property notifies the Trust of the intent to prepay or as it matures.
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Within the 90 days prior to the date of this Quarterly Report on Form 10-Q, the
Chief Executive Officer and Chief Accounting Officer carried out an evaluation
of the effectiveness of the design and operation of the Trust's disclosure
controls and procedures. Based upon that evaluation, the Chief Executive Officer
and the Chief Accounting Officer concluded that the Trust's disclosure controls
and procedures were effective as of the date of their evaluation in timely
alerting them to material information relating to the Trust required to be
included in this Quarterly Report on Form 10-Q.
(b) Changes in Internal Controls
There were no significant changes in the Trust's internal controls or in other
factors that could significantly affect such internal controls subsequent to the
date of the evaluation described in paragraph (a) above.
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KRUPP GOVERNMENT INCOME TRUST
PART II - OTHER INFORMATION
----------
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
--------
(10.1) Third Modification Agreement dated September 8, 2003, by
and among Krupp Government Income Trust, a Massachusetts
business trust; Mountain View, LTD, an Alabama limited
partnership; and Philip P. Mulkey, Henry V. Bragg and
Gregory V. Bragg.
(31.1) Chief Executive Officer Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
(31.2) Chief Accounting Officer Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
(32.1) Chief Executive Officer Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(32.2) Chief Accounting Officer Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
-------------------
None
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Krupp Government Income Trust
(Registrant)
BY: /s/ Alan Reese
-------------------------------
Alan Reese
Treasurer and Chief Accounting
Officer of Krupp Government Income
Trust
Date: October 30, 2003
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