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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 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 0-20164
Krupp Government Income Trust II
(Exact name of registrant as specified in its charter)
Massachusetts 04-3073045
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
One Beacon Street, Boston, Massachusetts 02108
(Address of principal executive offices) (Zip Code)
(617) 523-0066
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title Name of exchange on which registered
- ----- ------------------------------------
Shares of Beneficial Interest None
Securities registered pursuant to Section 12(g) of the Act: None
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be continued, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
Form 10-K. |_|
SEC 1673 (11-03) Persons who 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.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Aggregate market value of voting securities held by non-affiliates: Not
applicable.
Documents incorporated by reference: see Item 15
The exhibit index is located on pages 15 - 17.
-1-
PART I
This Form 10-K contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Actual results could differ materially from
those projected in the forward-looking statements as a result of a number of
factors, including those identified herein.
ITEM 1. BUSINESS
Krupp Government Income Trust II (the "Trust") is a Massachusetts business trust
that was formed on February 8, 1991 and is authorized to sell up to 25,000,000
shares of beneficial interest (the "Shares"). Berkshire Realty Advisors Limited
Partnership acquired 10,000 of such Shares and 18,315,158 Shares were sold under
the Trust's public offering for $365,686,058, net of purchase volume discounts
of $617,102. On December 29, 1994, Berkshire Mortgage Advisors Limited
Partnership (the "Advisor") acquired Berkshire Realty Advisors Limited
Partnership's 10,000 Shares and assumed the role of the Advisor to the Trust.
Under the Dividend Reinvestment Plan ("DRP") of the Trust, 46,319 Shares were
sold for $880,061. The remaining 6,628,523 Shares are available for general
Trust purposes. The Trust has utilized the net proceeds from the public offering
and the DRP to acquire participating insured mortgages ("PIMs"), participating
insured mortgage investments ("PIMIs") and mortgage-backed securities ("MBS").
The Trust considers itself to be engaged in only one industry segment,
investment in mortgages.
The Trust has elected to be treated as a real estate investment trust ("REIT"),
under the Internal Revenue Code of 1986, as amended. The Trust shall terminate
on December 31, 2030, unless earlier terminated by the affirmative vote of
holders of a majority of the outstanding Shares entitled to vote thereon. See
Note A of the Notes to Financial Statements included in Appendix A of this
report on Form 10-K for additional information.
Although the Trust will terminate no later than December 31, 2030, the value of
the PIMIs and PIMs may be realized by the Trust through repayment or sale as
early as ten years from the closing dates of the permanent loans. Should the
Trust realize the value of all of its other investments within that time frame,
it may dissolve significantly prior to December 31, 2030.
An investment by the Trust in a PIM on a multi-family residential property
consists of (1) a MBS or an insured mortgage loan (the "guaranteed or insured
mortgage") guaranteed or insured as to principal and basic interest and (2) a
participating mortgage. Guaranteed or insured mortgages are issued or originated
under or in connection with the housing programs of Fannie Mae or the Federal
Housing Administration ("FHA") under the authority of the Department of Housing
and Urban Development ("HUD"). PIMs provide the Trust with monthly payments of
principal and basic interest and may also provide for Trust participation in the
current revenue stream and in the residual value, if any, from a sale or other
realization of the underlying property. The participation rights to the Trust
are conveyed through a subordinated promissory note and mortgage. The
participation features are neither insured nor guaranteed.
An investment by the Trust in a PIMI consists of (1) a MBS issued by Fannie Mae
and (2) an additional loan ("Additional Loan") to the borrower in excess of
mortgage amounts guaranteed by Fannie Mae that increases the Trust's total
financing with respect to that property. Additional Loans are collateralized by
a subordinated mortgage on the underlying property but are neither insured nor
guaranteed. Under the Additional Loans, the Trust receives semi-annual interest
payments and may provide additional interest in the future, including
participation in the net income and residual value, if any, of the underlying
property.
The Trust also has investments in MBS collateralized by single-family and
multi-family mortgage loans issued or originated by Fannie Mae, the Government
National Mortgage Association ("GNMA") or the Federal Home Loan Mortgage
Corporation ("FHLMC"). Fannie Mae, GNMA and FHLMC guarantee the principal and
interest of the Fannie Mae, GNMA and FHLMC MBS, respectively.
The Trust will distribute all proceeds from prepayments or other realizations of
mortgage assets to investors either through quarterly dividends or special
dividends.
The Trust anticipates that there will be sufficient cash flow from the mortgages
to meet cash requirements. To the extent that the Trust's cash flow should be
insufficient to meet the Trust's operating expenses and liabilities, it will be
necessary for the Trust to obtain additional funds by liquidating its investment
in one or more mortgages or by borrowing funds. The Trust may pledge mortgages
as security for any permitted borrowing of funds.
The Trust may not borrow funds in connection with the acquisition or origination
of mortgages. However, it may borrow funds in order to meet working capital
requirements of the Trust. In this event, the Trust may borrow funds from third
parties on a short-term basis. The declaration of trust of the Trust (the
"Declaration of Trust") limits the amount that may be borrowed by the Trust.
Borrowing agreements between the Trust and a lender may also restrict the amount
of indebtedness that the Trust may incur. The Declaration of Trust prohibits the
Trust from issuing debt securities to institutional lenders and banks, and the
Trust
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may not issue debt securities to the public except in certain limited
circumstances. The Trust, under some circumstances, may borrow funds from the
Advisor, a Trustee, or an affiliate of the Trust or a Trustee. However, a
majority of the independent Trustees, not otherwise interested in such
transaction, must approve the transaction as being fair, competitive and
commercially reasonable and no less favorable to the Trust than loans between
unaffiliated lenders and borrowers under the same circumstances. The Trust has
not borrowed any funds in the past and does not intend to do so in the future.
The FHA coinsurance loan program under Section 221(d)(4) of the National Housing
Act provides for loans with 40-year terms. However, this program allows for a
call option at any time after ten years, upon one year's notice. The Fannie Mae
Delegated Underwriting and Servicing Program provides for loans with seven, ten
or 15 year terms and an amortization period of 35 years. The subordinated
promissory notes and subordinated mortgages that secure the participation
feature of the PIMs and the notes that evidence the Additional Loans provide for
acceleration of maturity at the earlier of the sale of the underlying property
or the call date.
The Trust expects that, from time to time, it may realize the principal and
participation in residual value, if any, of its mortgages before maturity. It is
expected that the mortgages will be repaid after a period of ownership of
approximately ten years from the closing dates of the permanent loans.
Realization of the value of the mortgages may, however, be made at an earlier or
later date.
The Trust will not underwrite securities of other issuers, offer securities in
exchange for property or invest in securities of other issuers for the purpose
of exercising control and has not engaged in any of these activities in the
past. The Declaration of Trust does not permit the Trust to issue senior
securities. The Trust has not repurchased or reacquired any of its Shares from
shareholders in the past. The Trust may not make loans to the Advisor, any
Trustee, any affiliate of the Advisor or any Trustee or any other person, other
than mortgage investments of the type described above.
The Trust's investments are not expected to be subject to seasonal fluctuations,
although net income may vary somewhat from quarter to quarter based upon the
participation features of its investments. The requirements for compliance with
federal, state and local regulations to date have not had a material adverse
effect upon the Trust's operations, and the Trust anticipates no material
adverse effect in the future.
To qualify as a REIT for federal income tax purposes, the Trust made a valid
election to be so treated and must continue to satisfy a range of complex
requirements including criteria related to its ownership structure, the nature
of its assets, the sources of its income and the amount of its dividends to
shareholders. The Trust intends to qualify as a REIT in each year of operation;
certain factors, however, may have an adverse effect on the Trust's REIT status.
If, for any taxable year, the Trustees and the Advisor determine that any of the
asset, income, or dividend criteria are not likely to be satisfied, the Trust
may be required to borrow funds, dispose of mortgages or take other action to
avoid the loss of its REIT status.
Additionally, if the Trust does not qualify as a REIT for any taxable year, it
will be subject to federal income tax as if it were a corporation and the
shareholders will be taxed as shareholders of a corporation. If the Trust were
taxed as a corporation, the payment of such tax by the Trust would substantially
reduce the funds available for dividends to shareholders. To the extent that
dividends had been made in anticipation of the Trust's qualification as a REIT,
the Trust might be required to borrow additional funds or to liquidate certain
of its investments in order to pay the applicable tax. Moreover, should the
Trust's election to be taxed as a REIT be terminated or voluntarily revoked, the
Trust may not be able to elect to be treated as a REIT for the following
five-year period.
As of December 31, 2003, no personnel were directly employed by the Trust.
ITEM 2. PROPERTIES
None.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Trust, any
director, officer or affiliate of the Trust is a party to which would have a
materially adverse effect on the Trust. There are no material pending legal
proceedings relating to any of the Trust's investments.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-3-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Currently there is no established public trading market for the Shares.
The number of investors holding Shares as of December 31, 2003 was approximately
7,800.
The Trust has declared and paid dividends on a quarterly basis, and intends to
continue to do so for the foreseeable future. The Trustees established a
dividend rate per Share per quarter of $0.14 for each quarter of 2003 and for
the third and fourth quarter of 2002 and $0.24 per share for the first and
second quarter of 2002. Effective with the May 2004 dividend, the dividend rate
per share per quarter will be $0.05 per share.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial information regarding the
Trust's financial position and operating results. This information should be
read in conjunction with Management's Discussion and Analysis of Financial
Condition and Results of Operations and the Financial Statements and
Supplementary Data, which are included in Item 7 and Item 8 Appendix A of this
report, respectively.
(Amounts in thousands, except for per Share amounts)
2003 2002 2001 2000 1999
------- -------- -------- -------- --------
Total revenues $11,498 $ 17,359 $ 25,330 $ 16,978 $ 19,613
Net income $ 8,785 $ 14,037 $ 22,141 $ 13,625 $ 14,974
Net income per Share $ .48 $ .76 $ 1.21 $ .74 $ .82
Weighted average Shares
outstanding 18,371 18,371 18,371 18,371 18,371
Total assets at December 31 $51,387 $132,860 $167,764 $215,521 $231,209
Average dividends per Share $ 4.90 $ 2.61 $ 3.74 $ 1.62 $ 2.73
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements in this Management's Discussion and Analysis of Financial
Condition and Results of Operations and elsewhere in this report on Form 10-K
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 December 31, 2003, the Trust had liquidity consisting of cash and cash
equivalents of approximately $5.45 million, as well as the cash inflows provided
by the remaining PIM, PIMIs, MBS and cash and cash equivalents. The Trust may
also receive additional cash flow from the participation features of its
remaining PIM and PIMIs. The Trust anticipates that these sources will be
adequate to provide the Trust with sufficient liquidity to meet its obligations,
including providing dividends to its investors.
The most significant demands on the Trust's liquidity are quarterly dividends
paid to investors of approximately $2.6 million, which represents the current
quarterly dividend rate of $0.14 per share. Dividends are funded by interest
income received on the
-4-
remaining PIM, PIMIs, MBS and cash and cash equivalents, net of operating
expenses, and the principal collections received on its remaining PIM, PIMIs and
MBS. The portion of dividends funded from principal collections reduces the
capital resources of the Trust. As the capital resources of the Trust decrease,
the total cash flows to the Trust will also decrease which may result in
periodic adjustments to the dividends paid to the investors.
The Advisor periodically reviews the dividend rate to determine whether an
adjustment is necessary based on projected future cash flows. The current
dividend rate is $0.14 per share per quarter. The Trustees, based on the
Advisor's recommendations, generally set a dividend rate that provides for level
quarterly distributions. To the extent quarterly dividends do not fully utilize
the cash available for distribution and cash balances increase, the Trustees may
adjust the dividend rate or distribute such funds through a special dividend.
The Advisor made a recommendation to the Trustees at the November 2003 Board
Meeting to reduce the dividend rate from $0.14 per share to $0.05 per share
effective with the May 2004 dividend. The Trustees approved the recommendation
to reduce the dividend rate.
In addition to providing guaranteed or insured monthly principal and interest
payments from the insured first mortgage or Fannie Mae MBS portion of a PIM or
PIMI, the Trust's investments in the remaining PIM and PIMIs also may provide
additional income through the interest on the Additional Loan portion of the
PIMIs as well as participation interest based on operating cash flow and
increase in the value realized upon the sale or refinance of the underlying
properties. However, these payments and collection of the Additional Loan
principal are neither guaranteed nor insured and depend on the successful
operations of the underlying properties.
For the year ended December 31, 2003, the Trust received both installments of
Additional Loan interest due in 2003 from its remaining PIMI investments.
The Trust received participation interest based on cash flow generated by
property operations from three of its investments during the twelve months ended
December 31, 2003. Mill Ponds II paid $19,309, Martins Landing paid $138,603 and
the Lakes paid $260,508. In addition, the Trust received and recognized
participation interest related to the Oasis at Springtree Additional Loan payoff
and the Crossings Village Additional Loan payoff.
During the first quarter of 2003, the Trust refunded $54,258 of participation
interest received in 2000 and 2001 to the borrower on the Fountains PIM. The
refund was due to an overpayment of participation interest by the borrower as a
result of an error the borrower made its initial surplus cash calculations for
2000 and 2001. Upon reexamination, the borrower determined that certain proceeds
were incorrectly included in those calculations. The borrower then submitted
revised surplus cash calculations to the Advisor and, upon review, the Advisor
determined that a refund was due to the borrower.
On December 22, 2003, the Trust received a prepayment of the Fountains
Apartments PIM for $9,998,884. The Trust also received a prepayment premium of
$225,901. An appraisal of the property determined that the underlying property
value had not increased sufficiently to meet the criteria for the Trust to earn
any participation interest. On December 30, 2003, the Trust paid a special
dividend of $0.56 per share from the proceeds received.
On September 30, 2003, the Trust received a prepayment of the Crossings Village
Subordinated Promissory Note and the Crossings Village Additional Loan. The
Trust received $2,584,000 of Additional Loan principal and $15,073 of Additional
Loan interest. In addition, the Trust received $2,454,048 of Preferred Interest
and $38,646 of Shared Appreciation Interest. On October 25, 2003, the Trust
received $11,349,632 from the Fannie Mae MBS related to Crossings Village. On
November 20, 2003, the Trust paid a special dividend of $0.90 per share from the
proceeds of the Crossings Village Apartments prepayment.
On September 25, 2003, the Trust received a payoff of the Oasis at Springtree
MBS for $11,116,057. On October 7, 2003, the Trust paid a special dividend of
$0.61 per share from the principal proceeds received.
On September 18, 2003, the Trust received a prepayment of the Rivergreens
Apartments II PIM for $5,845,000. The Trust also received a prepayment premium
of $58,450 from this payoff. On September 30, 2003, the Trust paid a special
dividend of $0.33 per share from the proceeds of the Rivergreens Apartments II
PIM prepayment. Rivergreens II was a participating insured mortgage that was not
required to simultaneously pay off the Subordinated Promissory Note with the
first mortgage. On December 8, 2003, the Trust received a payment of the
Rivergreens Apartments II Subordinated Promissory Note. The Trust received
$303,593 of Shared Appreciation Interest. On December 17, 2003, the Trust paid a
special dividend of $0.02 per share from the proceeds received.
On March 25, 2003, the Trust received a payoff of the Willows MBS for
$3,280,432. On May 9, 2003, the Trust paid a special dividend of $0.18 per share
from the principal proceeds.
On March 7, 2003, the Trust received a prepayment of the Oasis at Springtree
Additional Loan note. The Trust received $2,290,000 of Additional Loan principal
and $2,365,276 of Shared Appreciation Interest. On May 8, 2003, the Trust paid a
-5-
special dividend of $0.26 per share from the proceeds of the Oasis at Springtree
Additional Loan prepayment. As a result of the prepayment, the insured first
mortgage loan on Oasis at Springtree was reclassified from a PIMI to a MBS, as
the only remaining portion of the investment was a FNMA MBS. The Trust also
reclassified this investment as available-for-sale concurrent with the
satisfaction of the participation feature. The Trust continued to receive the
scheduled principal and interest payments on the first mortgage until it was
paid in full on September 25, 2003.
Due to the significant number of prepayments of mortgage investments in 2003,
the Trust saw a decrease in its overall mortgage investments of approximately
59% during 2003. In addition, due to the cumulative prepayments since inception
through December 31, 2003, the Trust has approximately 14% of its original
mortgage investments remaining.
On December 30, 2002, the Trust received a prepayment of the Mequon Trails PIM
participation feature totaling $572,226. The payoff consisted of $385,000 of
Shared Appreciation Interest and $187,226 of Minimum Additional Interest and
Shared Income Interest. On January 27, 2003, the Trust received $13,007,834 in
proceeds from the Fannie Mae MBS related to Mequon. On May 7, 2003, the Trust
paid a special dividend of $0.74 per share from the proceeds of the Mequon
Trails PIM prepayment.
On November 25, 2002, the Trust received $4,488,878, as a result of the payoff
of the Sunset Summit Additional Loan. The payoff consisted of $1,900,000 for the
principal due on the Additional Loan, base interest of $33,250, Preferred
Interest of $1,532,498 and Participating Appreciation Interest of $1,023,130. On
December 26, 2002, the Trust received $9,094,934 in proceeds from the Fannie Mae
MBS related to Sunset. On May 5, 2003, the Trust paid a special dividend of
$0.74 per share from the proceeds received in 2002 from the Sunset Summit PIMI
payoff.
On March 28, 2002, the Trust received a prepayment of the Windmill Lakes
Subordinated Promissory Note and the Windmill Lakes Additional Loan. The Trust
received $2,000,000 of Additional Loan principal and $162,500 of Additional Loan
interest. As a result of the payoff, the Trust recognized $562,500 of Additional
Loan interest which had been received in prior years and was recorded as a
reduction of the impaired Additional Loan in accordance with the Financial
Accounting Standards Board's Statement 114, "Accounting by Creditors for
Impairment of a Loan" ("FAS 114") and the Financial Accounting Standard Board's
Statement 118, "Accounting by Creditors for Impairment of a Loan- Income
Recognition and Disclosures ("FAS118"). As the entire Additional Loan principal
balance of $2,000,000 was paid in 2002, the remaining impairment provision of
$500,000 was also reversed. On April 25, 2002, the Trust received $10,727,382 in
principal proceeds on the first mortgage note from Windmill Lakes. The Trust
paid a special dividend of $0.71 per share from the proceeds of the Windmill
Lakes prepayment on May 1, 2002.
On February 13, 2002, the Trust received a prepayment of the Norumbega Pointe
Subordinated Promissory Note and the Norumbega Pointe Additional Loan. The Trust
received $3,063,000 of Additional Loan principal, $302,877 of Shared
Appreciation Interest and $2,280,362 of Preferred Interest. On February 25,
2002, the Trust received $15,123,167 in principal proceeds on the first mortgage
note. In addition, the Trust recognized $1,242,282 of Additional Loan interest
that had been previously received and recorded as deferred income on the
Additional Loan. The Trust paid a special dividend of $1.14 per Share from the
proceeds of the Norumbega Pointe prepayment on March 12, 2002.
On July 23, 2001, the Trust received a prepayment of the Seasons Subordinated
Promissory Note and the Seasons Additional Loan. The Trust received $4,925,351
of the Additional Loan principal, $462,983 of surplus cash, $2,168,701 of
preferred interest, $2,693,326 of contingent interest, $176,908 of unpaid Base
Interest on Additional Loan and $3,325,696 which represents the Trust's portion
of the residual split. On July 26, 2001, the Trust received $21,926,006 in
principal proceeds on the first mortgage note. In addition, the Trust recognized
$624,023 of Additional Loan interest that had been previously received and
recorded in deferred income on Additional Loans. The Trust paid a special
dividend of $1.95 per Share on August 17, 2001 from the proceeds of the Seasons
PIMI prepayment.
The payoff of the Seasons PIMI was a result of the sale of the underlying
property by the borrower, Maryland Associates Limited Partnership ("MALP"),
which is an affiliate of the Advisor, to an affiliate of MALP's general partner.
Because the sale of the underlying property was to an affiliate, the independent
Trustees of the Trust were required to approve the transaction. The independent
Trustees approved the transaction based upon a number of factors, including an
appraisal of the underlying property prepared by an independent third party MAI
appraiser. The purchase price paid by the affiliate for the underlying property
was $1.6 million greater than the value indicated by such appraisal. Both the
Trustees and the Advisor believed that the market capitalization rate utilized
in the appraisal was too high based on their knowledge of recent sales in the
market and agreed that the true fair value was the ultimate purchase price paid
by the affiliate.
On March 5, 2001, the Trust received a payoff of the Falls at Hunters Pointe
PIMI. The Trust received the outstanding balance on the insured mortgage of
$12,347,267, the outstanding balance on the Additional Loan of $650,000,
Participating Income Interest on the Additional Loan of $496,207 (including all
of the delinquent amounts), Preferred Interest on the Additional Loan of
$492,543, Participating Appreciation Interest under the subordinate loan
agreement of $1,070,304 and late fees on the delinquent Participating Income
Interest of $11,021. In addition, the Trust recognized $196,710 of Additional
Loan interest and
-6-
$311,132 of Participating Income Interest that had been previously received and
recorded in deferred income on Additional Loans. On March 20, 2001, the Trust
paid a special dividend of $0.83 per share from the proceeds of the Falls at
Hunters Pointe PIMI payoff.
Whether the operating performance of any of the remaining properties will
provide sufficient cash flow from operations to pay either the Additional Loan
interest or participation interest will depend on factors that the Trust has
minimal control over. Should the properties be unable to generate sufficient
cash flow to pay the Additional Loan interest, it would reduce the Trust's
distributable cash flow and could affect the value of the Additional Loan
collateral.
There are contractual restrictions on the prepayment of the remaining PIM and
PIMIs. During the first five years of the investment, borrowers are generally
prohibited from repayment. During the second five years, the PIM borrower can
prepay the insured mortgage by paying the greater of a prepayment premium or the
participation interest due at the time of the prepayment. Similarly, the PIMI
borrowers can prepay the insured mortgage and the Additional Loan by satisfying
the Preferred Return obligation. The participation features and the Additional
Loans are neither insured nor guaranteed. If the prepayment of the remaining PIM
or PIMI results from the foreclosure on the underlying property or an insurance
claim, the Trust generally would not receive any participation interest or any
amounts due under the Additional Loan. At this time, the Trust does not expect
the remaining PIM and PIMIs to be subject to an insurance claim or foreclosure.
The Trust has the option to call the remaining PIM and all of the PIMIs by
accelerating their maturity. If the call feature were exercised for an entire
PIM or PIMI, then the insurance feature of that loan would be cancelled.
Therefore, the Advisor will determine the merits of exercising the call option
for each PIM and PIMI as economic conditions warrant. The Advisor also has the
ability to modify or waive the prepayment premiums. 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 PIM and PIMI investments, impaired mortgage loans, amortization
of Prepaid Fees and Expenses and the carrying value of its MBS. The Trust's
policies are as follows:
The Trust accounts 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 has both the intention and ability to hold these
investments to expected maturity. The Trust carries these MBS at amortized cost.
The insured mortgage portion of the Federal Housing Administration ("FHA") PIM
or PIMI is carried at amortized cost. The Trust holds these mortgages at
amortized cost since they are fully insured by the FHA. The Additional Loans are
carried at amortized cost unless the Advisor 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 it will then be necessary to sell the remaining MBS portfolio 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. 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 HUD Insured
Mortgage loan (less the servicer's fee) or the coupon rate of the Fannie Mae
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 result of a 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 are from escrows established with the proceeds of the Additional Loan.
When the properties underlying the PIMIs 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
amortizing 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.
Impaired loans are those Additional Loans for which the Advisor believes the
collection of all amounts due in accordance with the contractual terms of the
loan agreement is not likely. Where necessary, 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. Interest received on
impaired loans is generally applied against the loan principal.
-7-
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 prepaid participation servicing fees are amortized 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 loan and at closing if a Fannie
Mae loan. 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Assessment of Credit Risk
The Trust's investments in insured mortgages and MBS are guaranteed and/or
insured by Fannie Mae, 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 Loans 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 changes in governmental regulations, real estate zoning laws, or
tax laws; and other circumstances over which the Trust may have little or no
control.
On December 31, 2003, the Trust's investments also include cash and cash
equivalents of approximately $4.9 million of Agency paper, which is issued by
Government Sponsored Enterprises with a credit rating equal to the top rating
category of a nationally recognized statistical rating organization.
Interest Rate Risk
The Trust's primary market risk exposure is to interest rate risk, which can be
defined as the exposure of the Trust's net income, comprehensive income or
financial condition to adverse movements in interest rates. At December 31,
2003, the Trust's remaining PIM, PIMIs and MBS comprise the majority of the
Trust's assets. Decreases in interest rates may accelerate the prepayment of the
Trust's investments. Increases in interest rates may decrease the proceeds from
a sale of the MBS. The Trust does not utilize any derivatives or other
instruments to manage this risk as the Trust plans to hold all of its PIM and
PIMI investments to expected maturity while it is expected that substantially
all of the MBS will prepay over the same time period thereby mitigating any
potential interest rate risk to the disposition value of any remaining MBS.
The Trust monitors prepayments and considers prepayment trends, as well as
dividend requirements of the Trust, when setting regular dividend policy. For
MBS, the fund forecasts prepayments based on trends in similar securities as
reported by statistical reporting entities such as Bloomberg. For the remaining
PIM and PIMIs, the Trust incorporates prepayment assumptions into planning as
individual properties notify the Trust of the intent to prepay or as they are
scheduled to mature.
The following table provides information about the Trust's financial instruments
that are sensitive to changes in interest rates. For mortgage investments, the
table presents principal cash flows and related weighted average interest rates
("WAIR") by expected maturity dates. The expected maturity date is the
contractual maturity as adjusted for expectations of prepayments.
-8-
Expected maturity dates ($ in thousands)
-----------------------------------------------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter Total Fair Value
Face (1)
Value
-----------------------------------------------------------------------------------------------------
Interest-sensitive assets:
MBS $ 954 $ 2,763 $ -- $ -- $ -- $ -- $ 3,717 $ 3,931
WAIR 8.01% 8.01% 8.01%
PIMS 7,866 -- -- -- -- -- 7,866 7,964
WAIR 7.13% 7.13%
PIMIS
Insured Mortgages 10,075 16,328 -- -- -- -- 26,403 27,068
WAIR 6.83% 6.83% 6.71%
Additional Loans 2,280 4,600 -- -- -- -- 6,880 6,880
WAIR 7.00% 7.00% 7.00%
---------- ---------- --------- --------- --------- ---------- ---------- ----------
Total Interest-
Sensitive Assets $ 21,175 $ 23,691 $ -- $ -- $ -- $ -- $ 44,866 $ 45,843
========== ========== ========= ========= ========= ========== ========== ==========
(1) The methodology used by the Trust to estimate the fair value of each class
of financial instrument is described in Note I to the Trust's financial
statements presented in Appendix A to this report. As described in that
note, the Trust does not include an estimate of value for the
participation interest associated with its PIM and PIMI investments.
Also included in the Trust's assets are cash and cash equivalents. Due to the
short-term maturity of these investments, generally less than three months, the
Trust is not exposed to significant interest rate risk on these investments.
Operations
The following relates to the operations of the Trust during the years ended
December 31, 2003, 2002, and 2001.
(amounts in thousands, except Share amounts)
Years Ended December 31,
------------------------
2003 2002 2001
---- ---- ----
Amount Amount Amount
------ ------ ------
Interest on PIMs and PIMIs:
Basic interest $ 4,147 $ 6,873 $ 9,674
Additional Loan interest 564 2,912 2,208
Participation interest 5,810 6,428 11,873
Interest income on MBS 757 860 1,197
Interest income - cash and cash equivalents 220 286 378
Trust expenses (1,385) (1,588) (2,081)
Amortization of prepaid fees and expenses (1,328) (2,234) (2,608)
Reduction of provision for
impaired Additional Loans -- 500 1,500
------------ ------------ ------------
Net Income $ 8,785 $ 14,037 $ 22,141
============ ============ ============
Weighted Average
Shares Outstanding 18,371,477 18,371,477 18,371,477
============ ============ ============
-9-
The Trust's net income decreased in 2003 when compared to 2002 primarily due to
decreases in basic interest on PIMs and PIMIs, Additional Loan interest,
participation interest, and a reduction in the provision for impaired mortgage
loans and an increase in expense reimbursements to affiliates. This decrease was
partially offset by decreases in amortization expense and asset management fees.
Basic interest on PIMs and PIMIs decreased primarily due to the Mequon Trails,
Rivergreens II and Crossings Village payoffs in 2003 and the Norumbega Pointe,
Windmill Lakes and Sunset Summit payoffs in 2002. Basic interest on PIMs and
PIMIs also decreased due to the reclassification of the Oasis at Springtree PIMI
to a MBS in March 2003. Additional Loan interest decreased primarily due to the
recognition in 2002 of deferred income from the Norumbega Pointe payoff, base
interest recognized from the Windmill Lakes payoff in 2002, the Sunset Summit
payoff in 2002 and the Oasis at Springtree and Crossings Village payoffs in
2003. Participation interest decreased primarily due to the participation
interest collected from the Norumbega Pointe, Mequon Trails and Sunset Summit
payoffs in 2002 exceeding the participation interest collected from the Oasis at
Springtree and Crossing Village payoffs in 2003. The reduction in the provision
for impaired mortgage loans was due to the reversal of the impairment provision
for the Windmill Lakes PIMI as a result of the Additional Loan payoff received
in the first quarter of 2002. No provisions for impaired mortgage loans were
made subsequent to the write off in 2002. Expense reimbursements to affiliates
increase primarily due to a change in the cost of services provided to the
Partnership in 2002 that was paid in 2003 and an increase in the cost of 2003's
services associated with the wind-down of the Trust's activities. Amortization
expense decreased as a result of the full amortization of the remaining prepaid
fees and expenses on the PIMI prepayments in 2002. Asset management fees
decreased due to the decrease in the Trust's investments as a result of
principal collection and payoffs.
The Trust's net income decreased in 2002 when compared to 2001 primarily due to
decreases in basic interest on PIMs and PIMIs, participation interest and a
reduction in the decrease of the provision for impaired mortgage loans. These
items were partially offset by an increase in Additional Loan interest. Basic
interest on PIMs and PIMIs decreased due to the Norumbega Pointe and Windmill
Lakes payoffs in 2002 and the payoff of the Falls at Hunters Pointe and the
Seasons PIMIs in 2001. Participation interest decreased primarily due to the
participation interest collected from the Seasons and Hunters Pointe payoffs in
2001 being greater than the participation interest collected from the Norumbega,
Falls at Hunters Pointe, Sunset Summit and Mequon Trails payoffs in 2002. The
provision for impaired mortgage on the Windmill Lakes PIMI decreased by
$1,500,000 in 2001 whereas it only decreased by $500,000 in 2002. Additional
Loan interest increased primarily due to the recognition of deferred income from
the Norumbega Pointe payoff and base interest recognized from the Windmill Lakes
payoff.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Appendix A to this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Within the 90 days prior to the date of this Annual Report on Form 10-K, the
Chief Executive Officer and the 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 Annual Report on Form 10-K.
(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.
-10-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information as to the Trustees and Executive Officers of Krupp Government Income
Trust II is as follows:
Position with Krupp Date of Term
Name and Age Government Income Trust II Election Expires
------------ -------------------------- -------- -------
Douglas Krupp (57) Chairman of Board of Trustees and Trustee May, 1996 May, 2004
* Charles N. Goldberg (62) Trustee April, 1991 May, 2004
* J. Paul Finnegan (79) Trustee April, 1991 May, 2004
* Stephen Puleo (69) Trustee February, 2001 May, 2004
Peter F. Donovan (50) Chief Executive Officer July, 2003 N/A
Alan Reese (50) Treasurer February, 2003 N/A
Scott D. Spelfogel (43) Clerk November, 1991 N/A
MaryBeth Bloom (30) Assistant Clerk November, 2000 N/A
* Independent Trustee
Douglas Krupp co-founded and serves as Co-Chairman and Chief Executive Officer
of The Berkshire Group, an integrated real estate financial services firm
engaged in real estate acquisitions, property management, investment
sponsorship, venture capital investing, mortgage banking, financial management,
and ownership of one operating company through private equity investments. Mr.
Krupp has held the position of Co-Chairman since The Berkshire Group was
established as The Krupp Companies in 1969 and he has served as the Chief
Executive Officer since 1992. He is a graduate of Bryant College where he also
received an honorary Doctor of Science in Business Administration in 1989.
Charles N. Goldberg is currently a partner of Oppel, Goldberg & Saenz, PLLC.
Prior to that he was of counsel to the law firm of Broocks, Baker & Lange,
L.L.P., a position he held from December 1997 to May 2000. Prior to joining
Broocks, Baker & Lange, L.L.P., Mr. Goldberg was a partner in the law firm of
Hirsch & Westheimer from March 1996 to December 1997. Prior to Hirsch &
Westheimer, he was the Managing Partner of Goldberg Brown, Attorneys at Law from
1980 to March 1996. He received a B.B.A. degree and a J.D. degree from the
University of Texas. He is a member of the State Bar of Texas and is admitted to
practice before the U.S. Court of Appeals, Fifth Circuit and U.S. District
Court, Southern District of Texas. He currently serves as a Trustee of Krupp
Government Income Trust and Krupp Government Income Trust II.
J. Paul Finnegan retired as a partner of Coopers & Lybrand in 1987. Since then,
he has been engaged in business as a consultant, director and arbitrator. Mr.
Finnegan holds a B.A. degree from Harvard College, a J.D. degree from Boston
College Law School and an ASA from Bentley College. Mr. Finnegan currently
serves as a Trustee of Krupp Government Income Trust and Krupp Government Income
Trust II and as a director of Scituate Federal Savings Bank.
Stephen Puleo is currently engaged in business as a consultant and director. He
retired as a director of Coopers & Lybrand, where he worked from 1995 to 1997
primarily servicing real estate industry clients. From 1993 to 1994, Mr. Puleo
was a tax director for Deloitte & Touche. From 1984 to 1993, Mr. Puleo held the
positions of Executive Vice President and Chief Financial Officer of a
predecessor to The Berkshire Group. Prior to that, Mr. Puleo was the Chairman of
the National Real Estate Industry Group of Coopers & Lybrand where he provided
various real estate services and was a senior tax partner in charge of the
Northeast Region. He is a graduate of McNeese State University and attended the
Executive Development Program at the Tuck School of Business at Dartmouth
College. He is a Certified Public Accountant and currently serves as director of
Simpson Housing Limited Partnership of Denver, Colorado. He currently serves as
a Trustee of Krupp Government Income Trust and Krupp Government Income Trust II.
Peter F. Donovan is Chief Executive Officer of Berkshire Mortgage Finance which
position he has held since January of 1998 and in this capacity, he oversees the
strategic growth plans of this mortgage banking firm. Berkshire Mortgage Finance
is the 12th largest servicer of commercial mortgage loans in the United States
with a servicing and asset management portfolio of $18.3 billion. Previously he
served as President of Berkshire Mortgage Finance from January of 1993 to
January of 1998 and in that capacity he directed the production, underwriting,
servicing and asset management activities of the firm. Prior to that, he was
Senior Vice President of Berkshire Mortgage Finance and was responsible for all
participating mortgage originations. Before joining the firm in 1984, he was
Second Vice President, Real Estate Finance for Continental Illinois National
Bank & Trust, where he managed a $300 million construction loan portfolio of
commercial properties. Mr. Donovan received a B.A. from Trinity College and an
M.B.A. degree from Northwestern University. Mr. Donovan is currently a member of
the DUS Advisory Council for Fannie Mae.
-11-
Alan Reese is the Executive Vice President, Corporate Operations and Chief
Financial Officer of Berkshire Mortgage Finance. Mr. Reese joined Berkshire
Mortgage Finance in February of 2003 and is currently responsible for the
accounting, financial planning and reporting, treasury, mortgage trading desk
and loan servicing functions. Prior to joining Berkshire Mortgage Finance, Mr.
Reese was the Chief Financial Officer of Visible Markets, Inc. from 2000 to 2001
and was engaged in business as a consultant from 2001-January, 2003. Prior to
Visible Markets, Inc., he was the Senior Vice President and Chief Financial
Officer of Mortgage Lenders Network USA, Inc. from 1998-2000. Mr. Reese held
several positions with BankBoston Corporation from 1990 to 1998 and most
recently held the position of Director of Operations, National Consumer Lending
from 1996-1998. In addition, Mr. Reese was employed with Coopers & Lybrand from
1976 to 1990, and was a partner from 1987-1990. Mr. Reese presently serves on
the Board of Trustees for Berklee College of Music. He received a B.B.A. degree
from the University of Wisconsin - Eau Claire and is a Certified Public
Accountant.
Scott D. Spelfogel is the Clerk of the Trust and is Senior Vice President and
General Counsel to The Berkshire Group. Prior to 1997, he served as Vice
President and Assistant General Counsel. Before joining the firm in November
1988, he was a litigator in private practice in Boston. He received a Bachelor
of Science degree in Business Administration from Boston University, a Juris
Doctor Degree from Syracuse University's College of Law, and a Master of Laws
degree in Taxation from Boston University Law School. He is admitted to practice
law in Massachusetts and New York, is a member of the American, Boston,
Massachusetts and New York State bar associations and is a licensed real estate
broker in Massachusetts.
MaryBeth Bloom is the Assistant Clerk of the Trust and is Assistant General
Counsel to The Berkshire Group. Prior to joining the company in August 2000, she
was an attorney with John Hancock Financial Services. She received a B.A. degree
from the College of the Holy Cross in 1995 and a J.D. degree from New England
School of Law in 1998. She is admitted to practice law in Massachusetts and New
York and is a member of the American Bar Association.
In addition, the following are deemed to be Executive Officers of the
registrant:
George Krupp (age 59) is the Co-Founder and Co-Chairman of The Berkshire Group,
an integrated real estate financial services firm engaged in real estate
acquisitions, property management, investment sponsorship, venture capital
investing, mortgage banking, financial management, and ownership of one
operating company through private equity investments. Mr. Krupp has held the
position of Co-Chairman since The Berkshire Group was established as The Krupp
Companies in 1969. Mr. Krupp attended the University of Pennsylvania and Harvard
University and holds a Master's Degree in History from Brown University. Douglas
and George Krupp are brothers.
Ronald Halpern (age 62) is President and Chief Operating Officer of Berkshire
Mortgage Finance. He has served in these positions since January 1998 and in
this capacity, he is responsible for the overall operations of the Company.
Prior to January 1998, he was Executive Vice President, managing the
underwriting, closing, portfolio management and servicing departments for
Berkshire Mortgage Finance. Before joining the firm in 1987, he held senior
management positions with the Department of Housing and Urban Development in
Washington D.C. and several HUD regional offices. Mr. Halpern has over 30 years
of experience in real estate finance, which includes his experience as prior
Chairman of the Mortgage Bankers Association Multifamily Housing Committee. He
holds a B.A. degree from the University of the City of New York and J.D. degree
from Brooklyn Law School.
Carol J.C. Mills (age 54) is Senior Vice President for Loan Management of
Berkshire Mortgage Finance and in this capacity, she is responsible for the
Asset Management functions of Berkshire Mortgage Finance. She manages the
estimated $18.3 billion portfolio of loans. Ms. Mills joined Berkshire in
December 1997 as Vice President and was promoted to Senior Vice President in
January 1999. From January 1989 through November 1997, Ms. Mills was Vice
President of First Winthrop Corporation and Winthrop Financial Associates, in
Cambridge, Massachusetts. Ms. Mills earned a B.A. degree from Mount Holyoke
College and a Master of Architecture degree from Harvard University. Ms. Mills
is a member of the Real Estate Finance Association, New England Women in Real
Estate, the Mortgage Bankers Association and the Servicing Advisory Council for
Freddie Mac.
ITEM 11. EXECUTIVE COMPENSATION
Except for the Independent Trustees (as described below), the Trustees and
Officers of the Trust have not been and will not be compensated by the Trust for
their services. However, the Officers will be compensated by the Advisor or an
affiliate of the Advisor.
Compensation of Trustees
The Trust paid each of the Independent Trustees (Charles N. Goldberg, J. Paul
Finnegan and Stephen Puleo) a fee of $25,000 in 2003.
-12-
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of January 21, 2004, the following were known by the Advisor to own
beneficially more than 5% of the Trust's 18,371,477 outstanding Shares. The only
Shares held by the Advisor or any of its affiliates consist of the original
10,000 Shares held by the Advisor.
The amounts and percentages of Shares beneficially owned are reported on the
basis of regulations of the SEC governing the determination of beneficial
ownership of securities. Under these rules, a person is deemed to be a
beneficial owner of a security if that person has or shares voting power, which
includes the power to vote or to direct the voting of such security, or
investment power, which includes the power to dispose of or to direct the
disposition of such security. A person is also deemed to be a beneficial owner
of any securities of which that person has a right to acquire beneficial
ownership within 60 days. Under these rules, more than one person may be deemed
to be a beneficial owner of the same securities.
Class of Name of Beneficial Amount and Nature of Percent
Stock Owner Beneficial Interest of Class
- -------- ------------------ -------------------- --------
Shares of Berkshire Income Realty - OP, L.P. ("BIR - OP") 5,293,322 Shares (1) 28.81%
Beneficial One Beacon Street, Suite 1500
Interest Boston, MA 02108
Shares of Berkshire Income Realty, Inc. ("BIR") 5,293,322 Shares (1) (a) 28.81%
Beneficial One Beacon Street, Suite 1500
Interest Boston, MA 02108
Shares of BIR GP, L.L.C. 5,293,322 Shares (2) 28.81%
Beneficial One Beacon Street, Suite 1500
Interest Boston, MA 02108
Shares of KRF Company, L.L.C. 5,293,322 Shares (3) 28.81%
Beneficial One Beacon Street, Suite 1500
Interest Boston, MA 02108
Shares of The Krupp Family Limited Partnership - 94 5,293,322 Shares (4) 28.81%
Beneficial One Beacon Street, Suite 1500
Interest Boston, MA 02108
Shares of The George Krupp 1980 Family Trust 5,293,322 Shares (5) 28.81%
Beneficial One Beacon Street, Suite 1500
Interest Boston, MA 02108
Shares of The Douglas Krupp 1980 Family Trust 5,293,322 Shares (5) 28.81%
Beneficial One Beacon Street, Suite 1500
Interest Boston, MA 02108
Shares of George D. Krupp 5,293,322 Shares (6) 28.81%
Beneficial c/o Berkshire Income Realty, Inc.
Interest One Beacon Street, Suite 1500
Boston, MA 02108
Shares of Douglas Krupp 5,293,322 Shares (6) 28.81%
Beneficial c/o Berkshire Income Realty, Inc.
Interest One Beacon Street, Suite 1500
Boston, MA 02108
Shares of Douglas Krupp 10,000 Shares (7) **
Beneficial One Beacon Street
Interest Boston, MA 02108
Shares of All Directors and Officers 10,000 Shares **
Beneficial One Beacon Street
Interest Boston, MA 02108
-13-
(1) In connection with the April 4, 2003 closing of BIR's offer to exchange
shares of it's 9% Series A Cumulative Redeemable Preferred Stock,
liquidation value $25 per share ("Preferred Stock") for shares of
beneficial interest ("Shares") in Krupp Government Income Trust II ("the
Trust"), BIR acquired 5,293,322 Shares of the Trust. On April 4, 2003, BIR
contributed such shares to BIR - OP in exchange for 100% of the preferred
limited partnership interest in BIR - OP. BIR also owns 100% of the
limited liability company interests of BIR GP, L.L.C., the general partner
of BIR - OP. By virtue of such interests, BIR may be deemed to
beneficially own indirectly the Shares of the Trust owned by BIR - OP.
(a) Per the form of Amended and Restated Voting Agreement (the "Voting
Agreement") between BIR and the Trust, BIR shall vote with respect to any
matter brought before such holders of Shares, all of the BIR Shares in
proportion to the votes cast by the other holders of Shares of the Trust.
In each case where BIR is a beneficial owner of Shares, BIR effectively
has no voting or investment powers in the Trust.
(2) BIR GP, L.L.C. owns 100% of the general partnership interests in BIR - OP,
and by virtue of such interest, BIR GP, L.L.C. may be deemed to
beneficially own indirectly the Shares of the Trust owned by BIR - OP.
(3) KRF Company, L.L.C. owns 100% of the common limited partnership interests
in BIR - OP and 100% of the common stock of BIR, and by virtue of such
interests, KRF Company, L.L.C. may be deemed to beneficially own
indirectly the Shares of the Trust owned by BIR - OP.
(4) The Krupp Family Limited Partnership - 94 owns 100% of the limited
liability company interests in KRF company, L.L.C., and by virtue of such
interest, The Krupp Family Limited Partnership - 94 may be deemed to
beneficially own indirectly the Shares of the Trust owned by BIR - OP.
(5) Each of the Douglas Krupp 1980 Family Trust and The George Krupp 1980
Family Trust owns 50% of the limited partnership interests in the Krupp
Family Limited Partnership - 94, and by virtue of such interests, The
Douglas Krupp 1980 Family Trust and The George Krupp 1980 Family Trusts
each may be deemed to beneficially own indirectly the Shares of the Trust
owned by BIR - OP. The trustees of The Douglas Krupp 1980 Family Trust are
Paul Krupp, Lawrence Silverstein and Vincent O'Reilly, and the trustees of
the George Krupp 1980 Family Trust are Paul Krupp and Lawrence
Silverstein. Each of the trustees of The Douglas Krupp 1980 Family Trust
and The George Krupp 1980 Family Trust disclaims beneficial ownership of
any such Shares of the Trust that are or may be deemed to be beneficially
owned by Douglas Krupp, George D. Krupp, The Douglas Krupp 1980 Family
Trust or The George Krupp 1980 Family Trust.
(6) The general partners of The Krupp Family Limited Partnership - 94 are
George D. Krupp and Douglas Krupp, each of whom owns 50% of the general
partner interests in the Krupp Family Limited Partnership - 94, and by
virtue of such interests, George D. Krupp and Douglas Krupp each may be
deemed to beneficially own indirectly the Shares of the Trust owned by BIR
- OP.
(7) Mr. Krupp is a beneficial owner of the 10,000 Shares held by Berkshire
Mortgage Advisors Limited Partnership, the Advisor to the Company, by
virtue of being a director of Berkshire Funding Corporation, the general
partners of Berkshire Mortgage Finance Limited Partnership. In each case
where Mr. Krupp is a beneficial owner of Shares he has shared voting and
investment powers.
** The amount owned does not exceed one percent of the Shares of beneficial
interest of the Trust outstanding as of January 21, 2004.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Under the terms of the Advisory Service Agreement, the Advisor receives an Asset
Management Fee equal to .75% per annum of the value of the Trust's actual and
committed invested assets payable quarterly. During 2003, the Advisor received
$587,877 in Asset Management Fees.
The Trust also reimburses affiliates of the Advisor for certain expenses
incurred in connection with maintaining the books and records of the Trust, the
preparation and mailing of financial reports, tax information and other
communications to investors, and legal fees and expenses. During 2003, The
Berkshire Companies Limited Partnership and Berkshire Mortgage Finance Limited
Partnership, affiliates of the Advisor, received a total of $406,564 in
reimbursements from the Trust.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following is a summary of the fees billed to the Trust by
PricewaterhouseCoopers LLP for professional services rendered for the fiscal
years ended December 31, 2003 and December 31, 2002:
-14-
Fee Category Fiscal 2003 Fees Fiscal 2002 Fees
- ------------ ---------------- ----------------
Audit Fees $ 37,000 $ 37,000
Audit-Related Fees -- 4,868
Tax Fees 3,675 3,500
----------------- ----------------
Total Fees $ 40,675 $ 45,368
================= ================
Audit Fees. Consists of fees billed for professional services rendered for the
audit of the Trust's annual financial statements and for the reviews of the
unaudited financial statements included in the Trust's Quarterly Reports on Form
10-Q during 2003.
Audit-Related Fees. Consists of fees billed for assurance and related services
that are reasonably related to the performance of the audit of the Trust's
annual financial statements and for the reviews of the unaudited quarterly
financial statements and are not reported under "Audit Fees." For 2002,
represents fees for S-11 research and SEC Comment Letter response in connection
with the BIR exchange offer.
Tax Fees. Consists of fees billed for professional services for tax compliance.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements - see Index to Financial Statements and
Supplementary Data included under Item 8, Appendix A, on page F-2 of
this report.
2. Financial Statement Schedules - see Index to Financial Statements
and Supplementary Data included under Item 8, Appendix A, on page
F-2 of this report. All schedules are omitted as they are not
applicable, not required or the information is provided in the
Financial Statements or the Notes thereto.
(b) Reports on Form 8-K
The Trust did not file any reports on Form 8-K during the quarter
ended December 31, 2003.
(c) Exhibits:
Number and Description
Under Regulation S-K
--------------------
The following reflects all applicable Exhibits required under Item 601 of
Regulation S-K:
(4) Instruments defining the rights of security holders including
indentures:
(4.1) Fourth Amended and Restated Declaration of Trust filed
with The Massachusetts Secretary of State on September 25,
1991 [Included as Exhibit 4.8 to Post-effective Amendment
No. 1 to Registrant's Registration Statement on Form S-11
dated September 26, 1991 (File No. 33-39033)].*
(4.2) Subscription Agreement Specimen [Included as Exhibit C to
Prospectus included in Post-effective Amendment No. 1 to
Registrant's Registration Statement on Form S-11 dated
September 26, 1991 (File No. 33-39033)].*
(10) Material Contracts
(10.1) Advisory Services Agreement dated September 11, 1991
between Krupp Government Income Trust II and Berkshire
Realty Advisors Limited Partnership (formerly known as
Krupp Realty Advisors Limited Partnership)[Exhibit 10.1 to
Registrant's report on Form 10-K for the year ended
December 31, 1994 (File No. 0-20164)].*
(10.2) Assignment and Assumption Agreement between Berkshire
Realty Advisors Limited Partnership and Berkshire Mortgage
Advisors Limited Partnership [Exhibit 10.2 to Registrant's
report on Form 10-K for the year ended December 31, 1994
(File No. 0-20164)].*
-15-
(10.3) Waiver and Standstill Agreement, dated as of August 22,
2002, by and among Krupp Government Income Trust, Krupp
Government Income Trust II, Berkshire Income Realty, Inc.
and Berkshire Income Realty - OP, L.P [Exhibit 10.3 to
Registrant's report on Form 10-K for the year ended
December 31, 2002 (File No. 0-20164)]*
(10.4) Form of Amended and Restated Voting Agreement among Krupp
Government Income Trust, Krupp Government Income Trust II
and Berkshire Income Realty, Inc. [Exhibit 10.4 to
Registrant's report on Form 10-K for the year ended
December 31, 2002 (File No. 0-20164)]*
(10.5) Extension and Waiver and Standstill Agreement, dated March
5, 2003, by and among Krupp Government Income Trust, Krupp
Government Income Trust II, Berkshire Income Realty, Inc.
and Berkshire Income Realty, OP, L.P. [Exhibit 10.5 to
Registrant's report on Form 10-K for the year ended
December 31, 2002 (File No. 0-20164)]*
Martin's Landing
(10.6) Subordinated Loan Agreement, dated November 9, 1993,
between TRC Realty Incorporated - ML, ML Associates
Limited Partnership ("Borrower") and Krupp Government
Income Trust II ("Holder") [Exhibit 10.9 to Registrant's
annual report on Form 10-K for fiscal year ended December
31, 1993 (File No. 0-20164)].*
(10.7) Subordination Agreement dated November 9, 1993 between ML
Associates, L.P., and Krupp Government Income Trust II.
[Exhibit 10.22 to Registrant's report on Form 10-K for the
year ended December 31, 1995 (File No. 0-20164)].*
(10.8) Assignment of Subordination Agreement dated November 9,
1993 from Berkshire Mortgage Finance Limited Partnership
to the Federal National Mortgage Association by and
between ML Associates, L.P., Berkshire Mortgage Finance
Limited Partnership and Krupp Government Income Trust II.
[Exhibit 10.23 to Registrant's report on Form 10-K for the
year ended December 31, 1995 (File No. 0-20164)].*
(10.9) Supplement to Prospectus dated December 1, 1993 for
Federal National Mortgage Association pool number MX -
073029. [Exhibit 10.24 to Registrant's report on Form 10-K
for the year ended December 31, 1995 (File No. 0-20164)].*
The Lakes
(10.10) Subordinated Loan Agreement dated June 29, 1995, between
Lake Associates, L. P. and Krupp Government Income Trust
II [Exhibit 10.5 to Registrant's report on Form 10-Q for
the quarter ended September 30, 1995 (File No. 0-20164)].*
(10.11) Subordinate Note dated June 29, 1995, between Lake
Associates, L. P. and Krupp Government Income Trust II
[Exhibit 10.6 to Registrant's report on Form 10-Q for the
quarter ended September 30, 1995 (File No. 0-20164)].*
(10.12) Subordinate Multifamily Mortgage to Secure Debt Agreement
dated June 29, 1995, between Lake Associates, L. P. and
Krupp Government Income Trust II [Exhibit 10.7 to
Registrant's report on Form 10-Q for the quarter ended
September 30, 1995 (File No. 0-20164)].*
(10.13) Subordination Agreement dated June 29, 1995, between
Berkshire Mortgage Finance Limited Partnership, Lake
Associates, L. P. and Krupp Government Income Trust II
[Exhibit 10.8 to Registrant's report on Form 10-Q for the
quarter ended September 30, 1995 (File No. 0-20164)].*
(10.14) Assignment of Subordination Agreement dated June 29, 1995,
from Berkshire Mortgage Finance Limited Partnership to the
Federal National Mortgage Association by and between, Lake
Associates, L.P. and Berkshire Mortgage Finance Limited
Partnership and Krupp Government Income Trust II [Exhibit
10.9 to Registrant's report on Form 10-Q for the quarter
ended September 30, 1995 (File No. 0-20164)].*
(10.15) Supplement to Prospectus dated November 1, 1994 for
Federal National Mortgage Association pool number MX -
073149 [Exhibit 10.10 to Registrant's report on Form 10-Q
for the quarter ended September 30, 1995 (File No.
0-20164)].*
-16-
Mill Pond II Apartments
(10.16) Mortgage Note dated July 26, 1994 for Mill Pond II Limited
Partnership and Krupp Mortgage Company Limited
Partnership. [Exhibit 10.101 to Registrant's report on
Form 10-K for the year ended December 31, 1995 (File No.
0-20164)].*
(10.17) Multifamily Subordinated Mortgage, Assignment of Rents and
Security Agreement dated July 26, 1994 between Mill Pond
II Limited Partnership and Krupp Government Income Trust
II. [Exhibit 10.102 to Registrant's report on Form 10-K
for the year ended December 31, 1995 (File No. 0-20164)].*
(10.18) Subordinated Promissory Note, dated July 26, 1994, between
Mill Pond II Limited Partnership and Krupp Government
Income Trust. [Exhibit 10.103 to Registrant's report on
Form 10-K for the year ended December 31, 1995 (File No.
0-20164)].*
(10.19) Agreement re Subordinated Note dated July 26, 1994,
between Berkshire Mortgage Finance Corporation and Krupp
Government Income Trust. [Exhibit 10.104 to Registrant's
report on Form 10-K for the year ended December 31, 1995
(File No. 0-20164)].*
(31) Other
(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) Other
(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.+
* Incorporated by reference
+ Filed herewith
-17-
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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, on the 18th day of March,
2004.
KRUPP GOVERNMENT INCOME TRUST II
By: /s/ Peter F. Donovan
-----------------------------------
Peter F. Donovan, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated, on the 18th day of March, 2004.
Signatures Title(s)
- ---------- --------
/s/ Peter F. Donovan Chief Executive Officer
- ---------------------------
Peter F. Donovan
/s/ Alan Reese Treasurer and Chief Accounting Officer of
- --------------------------- Krupp Government Income Trust II
Alan Reese
/s/ Douglas Krupp Chairman of the Board of Trustees and a
- --------------------------- Trustee of Krupp Government Income Trust II
Douglas Krupp
/s/ Charles N. Goldberg Trustee of Krupp Government Income Trust II
- ---------------------------
Charles N. Goldberg
/s/ J. Paul Finnegan Trustee of Krupp Government Income Trust II
- ---------------------------
J. Paul Finnegan
/s/ Stephen Puleo Trustee of Krupp Government Income Trust II
- ---------------------------
Stephen Puleo
-18-
APPENDIX A
KRUPP GOVERNMENT INCOME TRUST II
----------------------
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8 of FORM 10-K
ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION
For the Year Ended December 31, 2003
F-1
KRUPP GOVERNMENT INCOME TRUST II
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
----------------------
Report of Independent Auditors F-3
Balance Sheets at December 31, 2003 and 2002 F-4
Statements of Income and Comprehensive Income for the Years Ended December 31, 2003, 2002 and 2001 F-5
Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2003, 2002 and 2001 F-6
Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001 F-7
Notes to Financial Statements F-8 - F-18
Schedule II - Valuation and Qualifying Accounts F-19
Supplementary Data - Selected Quarterly Financial Data (Unaudited) F-20
All other schedules are omitted as they are not applicable or not required, or
the information is provided in the financial statements or the notes thereto.
F-2
REPORT OF INDEPENDENT AUDITORS
----------------------
To the Board of Trustees and Shareholders of
Krupp Government Income Trust II:
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Krupp
Government Income Trust II (the "Trust") at December 31, 2003 and 2002, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the accompanying index presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related financial statements. These financial statements
and financial statement schedule are the responsibility of the Trust's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 18, 2004
F-3
KRUPP GOVERNMENT INCOME TRUST II
BALANCE SHEETS
December 31, 2003 and 2002
----------------------
ASSETS
2003 2002
----------- ------------
Participating Insured Mortgage Investments
("PIMIs")(Notes B, C and I)
Insured mortgages $26,402,701 $ 49,641,101
Additional loans 6,880,000 11,754,000
Participating Insured Mortgages ("PIMs")
(Notes B, D and I) 7,865,941 36,817,984
Mortgage-Backed Securities ("MBS")
(Notes B, E and I) 3,930,944 11,521,401
----------- ------------
Total mortgage investments 45,079,586 109,734,486
Cash and cash equivalents (Notes B and I) 5,454,067 20,450,923
Interest receivable and other assets 399,184 893,646
Prepaid acquisition fees and expenses, net of
accumulated amortization of $1,861,827 and
$6,479,558, respectively (Note B) 329,295 1,286,992
Prepaid participation servicing fees, net of
accumulated amortization of $605,866 and
$1,991,606, respectively (Note B) 124,508 494,352
----------- ------------
Total assets $51,386,640 $132,860,399
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities $ 183,379 $ 47,848
----------- ------------
Shareholders' equity (Notes A and F):
Common stock, no par value; 25,000,000
Shares authorized; 18,371,477 Shares
issued and outstanding 51,067,705 132,302,504
Accumulated comprehensive income
(Notes B and E) 135,556 510,047
----------- ------------
Total Shareholders' equity 51,203,261 132,812,551
----------- ------------
Total liabilities and Shareholders' equity $51,386,640 $132,860,399
=========== ============
The accompanying notes are an integral
part of the financial statements.
F-4
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the Years Ended December 31, 2003, 2002, and 2001
----------------------
2003 2002 2001
------------ ------------ ------------
Revenues:
Interest income - PIMs and PIMIs:
Basic interest $ 4,147,405 $ 6,873,359 $ 9,673,656
Additional Loan interest 563,826 2,911,978 2,207,942
Participation interest 5,810,076 6,427,684 11,873,054
Interest income - MBS 756,572 859,519 1,197,120
Interest income - cash and cash equivalents 220,065 286,099 378,045
------------ ------------ ------------
Total revenues 11,497,944 17,358,639 25,329,817
------------ ------------ ------------
Expenses:
Asset management fee to an affiliate (Note G) 587,877 943,476 1,309,430
Expense reimbursements to affiliates (Note G) 386,494 219,194 267,554
Amortization of prepaid fees and expenses (Note B) 1,327,541 2,234,379 2,607,681
General and administrative (Note G) 410,593 424,208 504,174
Reduction of provision for impaired additional
loan (Notes B and C) -- (500,000) (1,500,000)
------------ ------------ ------------
Total expenses 2,712,505 3,321,257 3,188,839
------------ ------------ ------------
Net income (Notes B and H) 8,785,439 14,037,382 22,140,978
Other comprehensive income:
Net increase (decrease) in unrealized gain on MBS (374,491) 228,928 199,818
------------ ------------ ------------
Total comprehensive income $ 8,410,948 $ 14,266,310 $ 22,340,796
============ ============ ============
Basic earnings per Share $ .48 $ .76 $ 1.21
============ ============ ============
Weighted average Shares outstanding 18,371,477 18,371,477 18,371,477
============ ============ ============
The accompanying notes are an integral
part of the financial statements.
F-5
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2003, 2002 and 2001
----------------------
Accumulated Total
Retained Comprehensive Shareholders'
Common Stock Earnings Income Equity
------------- ------------ ------------- -------------
Balance at December 31, 2000 $ 212,783,023 $ -- $ 81,301 $ 212,864,324
Dividends (46,568,346) (22,140,978) -- (68,709,324)
Net income -- 22,140,978 -- 22,140,978
Change in unrealized gain on MBS -- -- 199,818 199,818
------------- ------------ --------- -------------
Balance at December 31, 2001 166,214,677 -- 281,119 166,495,796
Dividends (33,912,173) (14,037,382) -- (47,949,555)
Net income -- 14,037,382 -- 14,037,382
Change in unrealized gain on MBS -- -- 228,928 228,928
------------- ------------ --------- -------------
Balance at December 31, 2002 132,302,504 -- 510,047 132,812,551
Dividends (81,234,799) (8,785,439) -- (90,020,238)
Net income -- 8,785,439 -- 8,785,439
Change in unrealized gain on MBS -- -- (374,491) (374,491)
------------- ------------ --------- -------------
Balance at December 31, 2003 $ 51,067,705 $ -- $ 135,556 $ 51,203,261
============= ============ ========= =============
Shares issued and outstanding for each of the three years in the period ended
December 31 are 18,371,477.
The accompanying notes are an integral
part of the financial statements.
F-6
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2003, 2002 and 2001
----------------------
2003 2002 2001
------------ ------------ ------------
Operating activities:
Net income $ 8,785,439 $ 14,037,382 $ 22,140,978
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of net premium 16,421 74,010 75,585
Amortization of prepaid fees and expenses 1,327,541 2,234,379 2,607,681
Reduction of provision for impaired additional loans -- (500,000) (1,500,000)
Changes in assets and liabilities:
Decrease in interest receivable and other assets 494,462 280,460 378,462
Decrease in deferred income on Additional Loans -- (1,242,282) (1,261,322)
Increase (decrease) in liabilities 135,531 21,863 (127,288)
------------ ------------ ------------
Net cash provided by operating activities 10,759,394 14,905,812 22,314,096
------------ ------------ ------------
Investing activities:
Principal collections on MBS 18,348,402 4,234,205 3,647,045
Principal collections on Additional Loans 4,874,000 6,400,500 6,137,851
Principal collections on PIMs and Insured Mortgages 41,041,586 36,406,298 35,974,542
------------ ------------ ------------
Net cash provided by investing activities 64,263,988 47,041,003 45,759,438
------------ ------------ ------------
Financing activity:
Dividends (90,020,238) (47,949,555) (68,709,324)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (14,996,856) 13,997,260 (635,790)
Cash and cash equivalents, beginning of period 20,450,923 6,453,663 7,089,453
------------ ------------ ------------
Cash and cash equivalents, end of period $ 5,454,067 $ 20,450,923 $ 6,453,663
============ ============ ============
Non-cash activities:
Increase (decrease) in unrealized gain on MBS $ (374,491) $ 228,928 $ 199,818
============ ============ ============
Supplemental disclosure of non-cash investing activities:
Reclassification of investment in a PIMI to a MBS $ 11,199,153 $ -- $ --
============ ============ ============
The accompanying notes are an integral
part of the financial statements.
F-7
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS
----------------------
A. Organization
Krupp Government Income Trust II (the "Trust") was formed on February 8,
1991 by filing a Declaration of Trust in The Commonwealth of
Massachusetts. The Trust is authorized to sell and issue not more than
25,000,000 shares of beneficial interest (the "Shares"). The Trust was
organized for the purpose of investing in commercial and multi-family
loans and mortgage backed securities. Berkshire Mortgage Advisors Limited
Partnership (the "Advisor") acquired 10,000 of such Shares for $200,000
and 18,315,158 Shares were sold for $365,686,058 net of purchase volume
discounts of $617,102 under a public offering, which commenced on
September 11, 1991 and was completed on February 12, 1993. Under the
Dividend Reinvestment Plan ("DRP"), 46,319 Shares were sold for $880,061.
The Trust shall terminate on December 31, 2030, unless earlier terminated
by the affirmative vote of holders of a majority of the outstanding Shares
entitled to vote thereon.
B. Significant Accounting Policies
The Trust uses the following accounting policies for financial reporting
purposes:
Basis of Presentation
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with accounting principles generally
accepted in the United States of America ("GAAP").
MBS
The Trust, in accordance with the Financial Accounting Standards Board's
Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("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 it will then be necessary to sell the
remaining MBS portfolio 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. 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.
PIMs and PIMIs
The Trust accounts for its MBS portion of a PIM or PIMI investment in
accordance with 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 has
both the intention and ability to hold these investments to expected
maturity. The Trust carries these MBS at amortized cost.
The insured mortgage portion of the Federal Housing Administration ("FHA")
PIM or PIMI is carried at amortized cost. The Trust holds these mortgages
at amortized cost since they are fully insured by the FHA.
The Additional Loans are carried at amortized cost unless the Advisor
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".
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 Fannie Mae 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 are from escrows established with the proceeds of
the Additional Loan. When the properties underlying the PIMIs generate
sufficient cash flow to make the required Additional Loan interest
payments and the
Continued
F-8
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
B. Significant Accounting Policies, continued
PIMs and PIMIs, continued
Additional Loan value is deemed collectible, the Trust recognizes income
as earned and commences amortizing 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 Mortgage Loans
Impaired loans are those Additional Loans for which the Advisor believes
the collection of all amounts due in accordance with the contractual terms
of the loan agreement is not likely. Where necessary, 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. Interest received on impaired loans is generally applied
against the loan principal.
Cash Equivalents
The Trust includes all short-term investments with maturities of three
months or less from the date of acquisition in cash and cash equivalents.
The majority of the Trust's cash and cash equivalents are held at major
commercial banks which may at times exceed the Federal Deposit Insurance
Corporation limit of $100,000. The Trust has not experienced any losses to
date on its invested cash.
Prepaid Fees and Expenses
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 prepaid participation
servicing fees are amortized 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 loan and at closing if a Fannie
Mae loan.
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.
Income Taxes
The Trust has elected to be taxed as a REIT under the Internal Revenue
Code of 1986, as amended, and believes it will continue to meet all such
qualifications. Accordingly, the Trust will not be subject to federal
income taxes on amounts distributed to shareholders provided it
distributes annually at least 90% of its REIT taxable income and meets
certain other requirements for qualifying as a REIT. Therefore, no
provision for federal income taxes has been recorded in the financial
statements.
Estimates and Assumptions
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported
amount of assets and liabilities, contingent assets and liabilities and
revenues and expenses during the period. Significant estimates include the
net carrying value of Additional Loans and the unrealized gain on MBS
investments. Actual results could differ from those estimates.
Continued
F-9
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
C. PIMIs
The Trust had investments in two PIMIs at December 31, 2003 and four at
December 31, 2002 that provide or provided the permanent financing for
multi-family housing. Each remaining PIMI consists of a Fannie Mae MBS and
an "Additional Loan" made to the borrower to provide additional funds for
the construction or permanent financing of the property. The first
mortgage underlying the Fannie Mae MBS provided the borrower with a below
market interest rate loan, and in return, the Trust receives a percentage
of the cash generated from the property operations and a percentage of any
appreciation thereafter (collectively the "participation interest").
The borrower conveys the participation features to the Trust through the
Additional Loan on a Fannie Mae PIMI. The Trust makes the Additional Loan
under the Fannie Mae PIMIs directly to the borrower of the first mortgage
loan underlying the Fannie Mae MBS, and the borrower collateralizes the
Additional Loan with a subordinated mortgage on the property. The owners
of the borrower also pledge their ownership interests in the borrower as
additional collateral.
The Trust receives level monthly payments of principal and interest
payments, amortizing over thirty years on the Fannie Mae MBS. While
principal and interest payments on the Fannie Mae MBS are guaranteed,
there are limitations to the amount and obligation to pay interest under
the Additional Loan. As such amounts due under the Additional Loan are
neither insured nor guaranteed.
The Additional Loans for Fannie Mae PIMIs entitle the Trust to receive (i)
semi-annual interest payments on the Additional Loan principal, (ii)
Participating Income Interest, (iii) Participating Appreciation Interest
and (iv) Preferred Interest. Additional Loan interest accrues at the
stated interest rate on the Additional Loan and Participating Income
Interest represents the Trust's share of the net revenue generated by the
property at a stated percentage generally ranging from 25% to 35%.
Additional Loan interest and Participating Income Interest are payable
only to the extent there is net revenue available to pay these amounts.
However, should the borrower be unable to make the full Additional Loan
interest payment, the borrower must notify the Trust of the amount of the
shortfall.
The Trust can require the partners of the borrower to make a capital
contribution to the borrower to fund 50% of this shortfall, and the Trust
will fund the remainder with an Operating Loan. Also, the Trust is
generally limited to receiving no more than 50% of net revenue on any
semi-annual payment date. Participating Appreciation Interest provides the
Trust with a stated percentage, ranging from 25% to 30%, of the excess
value of the property over amounts due under the first mortgage,
Additional Loan and any Operating Loans, the repayment of capital
contributions, and a return of original equity to the partners of the
borrower.
Participating Appreciation Interest is due upon the sale, refinancing,
maturity or accelerated maturity, or permitted prepayment of all amounts
due under the insured mortgage and Additional Loan. Generally, the Trust
will not receive more than 50% of the excess of value over the outstanding
indebtedness, the payment of Preferred Interest, and the return of equity
and capital contributions to the partners of the borrower.
Preferred Interest refers to a non-compounded cumulative return from the
closing date of the loan to the date of calculation, at a stated interest
rate generally on the original outstanding balance of the insured mortgage
plus the Additional Loan and any other funds advanced to the borrower
(reduced by principal payments received) less: (i) interest payments on
the insured mortgage, (ii) Additional Loan interest, (iii) Participating
Income Interest, and (iv) Participating Appreciation Interest.
Generally, the amount of Preferred Interest owed cannot exceed the excess
of value over the outstanding indebtedness. Amounts due under the
Additional Loan are not guaranteed.
The Fannie Mae PIMIs have maturities of 15 years, however, the Trust can
accelerate the maturity dates at any time after the ninth or tenth
anniversary of the closing date of the Fannie Mae PIMIs, upon giving
twelve months written notice for the payment.
If the Trust accelerates the maturity date, the Trust can require payment
of all amounts due under the Additional Loan through the accelerated
maturity date and prepayment of the first mortgage loan underlying the
Fannie Mae MBS.
Continued
F-10
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
C. PIMIs, continued
Fannie Mae PIMIs generally cannot be prepaid during the five years
following the closing date of the underlying first mortgage loan.
Thereafter, the Fannie Mae first mortgage loan may be prepaid subject to a
prepayment penalty that declines each year for the next five years with no
prepayment penalty after the tenth year. Any prepayment of a Fannie Mae
PIMI generally requires prepayment of the first mortgage loan underlying
the Fannie Mae MBS and payment of amounts due under the Additional Loan.
The Fannie Mae first mortgage loan would not need to be prepaid if there
is a permitted assumption of the first mortgage loan, however, amounts due
under the Additional Loan would need to be prepaid. Any prepayment usually
requires not less than 90 nor more than 180 days prior written notice.
On September 30, 2003, the Trust received a prepayment of the Crossings
Village Apartments Subordinated Promissory Note and the Crossings Village
Apartments Additional Loan. The Trust received $2,584,000 of Additional
Loan principal and $15,073 of Additional Loan interest. In addition, the
Trust received $2,454,048 of Preferred Interest and $38,646 of Shared
Appreciation Interest. On October 25, 2003, the Trust received $11,349,632
from the Fannie Mae MBS related to Crossings Village. On November 20,
2003, the Trust paid a special dividend of $0.90 per share from the
proceeds of the Crossings Village Apartments prepayment.
On March 7, 2003, the Trust received a prepayment of the Oasis at
Springtree Additional Loan note. The Trust received $2,290,000 of
Additional Loan principal and $2,365,276 of Shared Appreciation Interest.
On May 8, 2003, the Trust paid a special dividend of $0.26 per share from
the proceeds of the Oasis at Springtree Additional Loan prepayment. As a
result of the prepayment, the insured first mortgage loan on Oasis at
Springtree was reclassified from a PIMI to a MBS as the only remaining
portion of the investment was a FNMA MBS. The Trust also reclassified this
investment as available-for-sale concurrent with the satisfaction of the
participation feature. The Trust continued to receive the scheduled
principal and interest payments on the first mortgage until it was paid in
full on September 25, 2003.
On November 25, 2002, the Trust received $4,488,878, as a result of the
payoff of the Sunset Summit Additional Loan. The payoff consisted of
$1,900,000 for the principal due on the Additional Loan, base interest of
$33,250, Preferred Interest of $1,532,498 and Participating Appreciation
Interest of $1,023,130. On December 26, 2002, the Trust received
$9,094,934 in proceeds from the Fannie Mae MBS related to Sunset. On May
5, 2003, the Trust paid a special dividend of $0.74 per share from the
proceeds received in 2002 from the Sunset Summit PIMI payoff.
On March 28, 2002, the Trust received a prepayment of the Windmill Lakes
Subordinated Promissory Note and the Windmill Lakes Additional Loan. The
Trust received $2,000,000 of Additional Loan principal and $162,500 of
Additional Loan interest. As a result of the payoff, the Trust recognized
$562,500 of Additional Loan interest which had been received in prior
years and was recorded as a reduction of the impaired Additional Loan. As
the entire Additional Loan principal balance of $2,000,000 was paid in
2002, the remaining impairment provision of $500,000 was also reversed. On
April 25, 2002, the Trust received $10,727,382 in principal proceeds on
the first mortgage note from Windmill Lakes. The Trust paid a special
dividend of $0.71 per share from the proceeds of the Windmill Lakes
prepayment on May 1, 2002.
On February 13, 2002, the Trust received a prepayment of the Norumbega
Pointe Subordinated Promissory Note and the Norumbega Pointe Additional
Loan. The Trust received $3,063,000 of Additional Loan principal, $302,877
of Shared Appreciation Interest and $2,280,362 of Preferred Interest. On
February 25, 2002, the Trust received $15,123,167 representing the
principal proceeds on the first mortgage note. In addition, the Trust
recognized $1,242,282 of Additional Loan interest that had been previously
received and recorded as deferred income on the Additional Loan. The Trust
paid a special dividend of $1.14 per share from the proceeds of the
Norumbega Pointe prepayment on March 12, 2002.
At December 31, 2003 and 2002 there are no PIMIs within the Trust's
portfolio that are delinquent as to principal or interest.
Continued
F-11
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
C. PIMIs, continued
The Trust's investments in PIMIs consists of the following at December 31,
2003 and 2002:
Approximate Balance Outstanding at December 31,
Insured Loan Monthly Interest Maturity -----------------------------------
Mortgage Amount Payments Rate Date 2003 2002
- ----------- ------ ----------- ---- ---- ----------- -----------
FNMA (a)
Crossings Village $12,907,334 $ -- -- -- $ -- $11,516,017
Martin's Landing 11,200,000 70,000 6.50% 12/01/08 9,773,837 9,970,854
Oasis 12,401,673 -- -- -- -- 11,247,702
The Lakes 18,387,653 118,700 6.825% 07/01/10 16,628,864 16,906,528
----------- ----------- ----------- -----------
$54,896,660 $ 188,700 $26,402,701 $49,641,101
=========== =========== =========== ===========
(b)
Base Preferred
Outstanding Balance Maturity Interest Interest
Additional Loan 2003 2002 Date Rate Rate
--------------- ------------- ------------- ---------- ------- -------
Crossings Village $ -- $ 2,584,000 -- -- --
Martin's Landing 2,280,000 2,280,000 12/01/08 7% 12%
Oasis -- 2,290,000 -- -- --
The Lakes 4,600,000 4,600,000 07/01/10 7% 9%
------------- -------------
$ 6,880,000 $ 11,754,000
============= =============
(c)
(a) Monthly principal and interest payments are based on a 30-year
amortization. The unpaid principal balances due at maturity are as
follows:
Martin's Landing $ 8,524,000
The Lakes $ 14,118,000
(b) The aggregate cost for federal income tax purposes is $26,402,701.
(c) The aggregate cost for federal income tax purposes is $6,880,000.
Continued
F-12
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
C. PIMIs, continued
Impaired Additional Loans
On December 31, 1998, as a result of continued deterioration in property
operations, the Advisor of the Trust determined that the Windmill Lakes
Additional Loan was impaired. As a result, a valuation allowance of
$2,000,000 was established to adjust the carrying amount of the loan to
the estimated fair market value of the collateral less anticipated costs
of sale. On July 25, 2001, the Trust received $512,500 in accrued but
unpaid base interest. The Trust reflected the $512,500 received plus
$50,000 previously received as a reduction in the principal balance of the
Additional Loan and related impairment provision. During the fourth
quarter of 2001, based on improved market conditions and property
operations, the Trust reduced the impairment provision by an additional
$937,500 to $500,000. As a result of the payoff received in March 2002,
the remaining impairment provision of $500,000 was reversed.
Reconciliations of activity for 2003, 2002 and 2001 are as follows:
Insured Mortgages
- -----------------
2003 2002 2001
------------ ------------ -------------
Balance at beginning of period $ 49,641,101 $ 85,625,185 $ 121,208,064
Principal collections (12,039,247) (35,984,084) (35,582,879)
Reclass to MBS (11,199,153) -- --
------------ ------------ -------------
Balance at end of period $ 26,402,701 $ 49,641,101 $ 85,625,185
============ ============ =============
Additional Loans
2003 2002 2001
------------ ------------ -------------
Balance at beginning of period $ 11,754,000 $ 17,654,500 $ 22,292,351
Interest received and recognized
as Additional Loan prepayment -- -- (562,500)
Additional Loan prepayments (4,874,000) (6,400,500) (5,575,351)
Adjustment to valuation allowance -- 500,000 1,500,000
------------ ------------ -------------
Balance at end of period $ 6,880,000 $ 11,754,000 $ 17,654,500
============ ============ =============
Property Descriptions:
o Martin's Landing Apartments ("Martin's Landing") is a 300-unit apartment
complex in Roswell, Georgia.
o The Lakes at Vinings Apartments ("The Lakes") is a 464-unit garden and
townhouse style apartment complex in Vinings, Georgia.
Continued
F-13
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
D. PIMS
The Trust has investments in one PIM at December 31, 2003 and four at
December 31, 2002.. The Trust's PIMs consist of either a Fannie Mae MBS or
a sole participation interest in a HUD-insured first mortgage loan
originated under the FHA lending program (collectively the "insured
mortgages") and participation interests in the revenue stream and
appreciation of the property above specified levels. The borrower conveys
these participation features to the Trust generally through a subordinated
promissory note and mortgage (the "Agreement"). The Trust receives level
monthly principal and interest payments, amortized over thirty to forty
years. The Fannie Mae MBS is guaranteed by Fannie Mae, and HUD insures
payment of principal and interest on the FHA first mortgage loan.
The borrower generally cannot prepay the insured mortgage during the first
five years but may prepay it thereafter subject to a 9% prepayment premium
in years six through nine, a 1% prepayment premium in year ten and no
prepayment premium thereafter. The Trust may receive interest related to
its participation interests in the underlying property, however, these
amounts are neither insured nor guaranteed. Generally, the participation
features consist of the following: (i) "Minimum Additional Interest" at
rates ranging from .5% to .75% per annum calculated on the unpaid
principal balance of the first mortgage on the underlying property, (ii)
"Shared Income Interest" ranging from 25% to 30% of the monthly gross
rental income generated by the underlying property in excess of a
specified base, but only to the extent that it exceeds the amount of
Minimum Additional Interest received during such month and (iii) "Shared
Appreciation Interest" ranging from 25% to 30% of any increase in value of
the underlying property in excess of a specified threshold. Payment of
participation interest from the operations of the property is limited to
50% of net revenue or surplus cash as defined by Fannie Mae or HUD,
respectively. The total amount of participation interest payable by the
borrower generally cannot exceed 50% of any increase in value of the
property.
Shared Appreciation Interest is payable when one of the following occurs:
(1) the sale of the underlying property to an unrelated third party on a
date which is later than five years from the date of the Agreement, (2)
the maturity date of the Agreement, or (3) prepayment of the Agreement.
Under the Agreement, the Trust, upon giving twelve months written notice,
can accelerate the maturity date of the Agreement and insured mortgage to
a date not earlier than ten years from the date of the Agreement for (a)
the payment of all participation interest due under the Agreement as of
the accelerated maturity date or (b) the payment of all participation
interest due under the Agreement plus all amounts due on the first
mortgage note on the property.
On December 22, 2003, the Trust received a prepayment of the Fountains
Apartments PIM for $9,998,884. The Trust also received a prepayment
premium of $225,901. An appraisal of the property determined that the
underlying property value had not increased sufficiently to meet the
criteria for the Trust to earn any participation interest. On December 30,
2003, the Trust paid a special dividend of $0.56 per share from the
proceeds received.
On September 18, 2003, the Trust received a prepayment of the Rivergreens
Apartments II PIM for $5,845,000. The Trust also received a prepayment
premium of $58,450 from this payoff. On September 30, 2003, the Trust paid
a special dividend of $0.33 per share from the proceeds of the Rivergreens
Apartments II PIM prepayment. Rivergreens II was a participating insured
mortgage that was not required to simultaneously pay off the Subordinated
Promissory Note with the first mortgage. On December 8, 2003, the Trust
received a payment of the Rivergreens Apartments II Subordinated
Promissory Note. The Trust received $303,593 of Shared Appreciation
Interest. On December 17, 2003, the Trust paid a special dividend of $0.02
per share from the proceeds received.
On December 30, 2002, the Trust received a prepayment of the Mequon Trails
PIM participation feature totaling $572,226. The payoff consisted of
$385,000 of Shared Appreciation Interest and $187,226 of Minimum
Additional Interest and Shared Income Interest. On January 27, 2003, the
Trust received $13,007,834 in proceeds from the Fannie Mae MBS related to
Mequon. On May 7, 2003, the Trust paid a special dividend of $0.74 per
share from the proceeds of the Mequon Trails prepayment.
At December 31, 2003 and 2002 there are no insured mortgage loans within
the Trust's portfolio that are delinquent of principal or interest.
Continued
F-14-
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
D. PIMs, continued
The Trust's PIMs consisted of the following at December 31, 2003 and 2002:
Approximate
Original Monthly Interest Maturity
PIM Amount Payments Rate Date Balance Outstanding at December 31,
--- ------ --------- ---- ---- -----------------------------------
2003 2002
--------------- --------------
FNMA
Mequon Trails $ 14,937,726 $ -- -- $ -- $ 13,007,834
FHA
Rivergreens II 6,137,199 -- -- -- 5,874,997
Mill Ponds II 8,245,300 51,900 7.125% 12/01/35 7,865,941 7,926,183
The Fountains 10,336,000 -- -- -- -- 10,008,970
-------------- ---------- ------------- --------------
Total $ 39,656,225 $ 51,900 $ 7,865,941 $ 36,817,984
============== ========== ============= ==============
(a)
(a) The aggregate cost for federal income tax purposes is $7,865,941.
Reconciliations of activity for 2003, 2002 and 2001 are as follows:
2003 2002 2001
------------ ------------ ------------
Balance at beginning of period $ 36,817,984 $ 37,239,922 $ 37,631,330
Discount amortization 50,297 276 255
Principal collections (29,002,340) (422,214) (391,663)
------------ ------------ ------------
Balance at end of period $ 7,865,941 $ 36,817,984 $ 37,239,922
============ ============ ============
Property description:
o Mill Ponds II Apartments ("Mill Ponds II") is a 150-unit apartment
complex in Bellbrook, Ohio.
E. Mortgage Backed Securities
At December 31, 2003, the Trust's MBS portfolio had an amortized cost of
$3,795,388 and gross unrealized gains of $135,556. At December 31, 2002
the Trust's MBS portfolio had an amortized cost of $11,011,354 and gross
unrealized gains of $510,047. The MBS have maturities ranging from 2008 to
2031.
On September 25, 2003, the Trust received a payoff of the Oasis at
Springtree MBS for $11,116,057. On October 7, 2003, the Trust paid a
special dividend of $0.61 per share from the principal proceeds received.
On March 25, 2003, the Trust received a payoff of the Willows MBS for
$3,280,432. On May 9, 2003, the Trust paid a special dividend of $0.18 per
share from the principal proceeds received.
Continued
F-15
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
E. Mortgage Backed Securities, continued
The Trust's MBS portfolio had the following contractual maturities as of
December 31, 2003:
Maturity Date Fair Value Unrealized Gain
------------- ---------------
2004 - 2008 $ 17,280 $ 446
2009 - 2013 83,872 2,548
2014 - 2031 3,829,792 132,562
------------- -----------
Total $ 3,930,944 $ 135,556
============= ===========
F. Shareholders' Equity
Under the Declaration of Trust, and commencing with the initial closing of
the public offering of Shares, the Trust has declared and paid dividends
on a quarterly basis. During the period in which the Trust qualifies as a
REIT, the Trust has and will pay quarterly dividends aggregating at least
90% of taxable income on an annual basis to be allocated to the
shareholders, in proportion to their respective number of shares.
In order for the Trust to maintain its REIT status with respect to the
requirements of Share ownership, the Declaration of Trust prohibits any
investor from owning, directly or indirectly more than 9.80% of the
outstanding Shares unless an exemption is granted by the Trustees and
empowers the Trustees to refuse to permit any transfer of Shares which, in
their opinion, would jeopardize the status of the Trust as a REIT.
On August 22, 2002, the Trustees agreed to waive the ownership limit to
allow affiliates of the Advisor to own up to 55% of the outstanding shares
of the Trust. The affiliates delivered an opinion of counsel to the effect
that this waiver will not cause the Trust to lose its status as a REIT. In
connection with this waiver, the affiliates also agreed not take any
action to cause the Trust to cease to be a reporting company under the
Exchange Act or to cause a majority of the board of trustees to no longer
be comprised of independent trustees. They also agreed not to solicit,
seek to effect, negotiate with or provide any information to any other
party with the intent of effecting a business combination with the Trust
without the approval of a majority of the board of trustees. In April of
2003, BIR acquired 28.81% of the outstanding shares of the Trust.
G. Related Party Transactions
Under the terms of the Advisory Service Agreement, the Advisor receives an
Asset Management Fee equal to .75% per annum of the value of the Trust's
actual and committed invested assets payable quarterly.
The Trust also reimburses affiliates of the Advisor for certain expenses
incurred in connection with maintaining the books and records of the
Trust, the preparation and mailing of financial reports, tax information
and other communications to investors and legal fees and expenses.
Included in general and administrative expenses are legal fees and
expenses paid by the Trust to an affiliate. During the three years ended
December 31, 2003, 2002 and 2001 these fees totaled $20,070, $16,083 and
$6,276, respectively.
The Trust earned or received $398,549 of base interest from The Seasons in
2001. In addition, the Trust received $8,780,579 in 2001 related to
participating interest income on those same loans.
Continued
F-16
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
H. Federal Income Taxes
The reconciliation of the income reported in the accompanying statement of
income with the income reported in the Trust's 2003 federal income tax
return follows:
Net income per statement of income $ 8,785,439
Less: Book to tax difference related to amortization of prepaid fees and expenses (2,018,168)
Less: Book to tax difference related to Additional Loan interest income (160,300)
-----------
Net income for federal income tax purposes $ 6,606,971
===========
The Trust paid dividends of $4.90 per share during 2003 which represents
approximately $0.34 from ordinary income and $4.56 represents a
non-taxable dividend for federal income tax purposes.
The basis of the Trust's assets for financial reporting purposes is less
than its tax basis by approximately $2,433,000 and $4,237,000 at December
31, 2003 and 2002, respectively. The basis of the Trust's liabilities for
financial reporting purposes were the same as its tax basis at December
31, 2003 and 2002.
I. Fair Value Disclosures of Financial Instruments
The Trust uses the following methods and assumptions to estimate the fair
value of each class of financial instrument:
Cash and Cash Equivalents
The carrying amount approximates fair value because of the short maturity
of those instruments.
MBS
The Trust estimates the fair value of MBS based on quoted market prices.
Based on the estimated fair value determined using these methods and
assumptions, the Trust's investments in MBS had gross unrealized gains of
approximately $136,000 at December 31, 2003 and gross unrealized gains of
approximately $510,000 at December 31, 2002.
PIMs and PIMIs
There is no established trading market for these investments. Management
estimates the fair value of the PIMs and the insured mortgage portion of
the PIMIs using quoted market prices of MBS having the same stated coupon
rate as the insured mortgages and similar expected maturity date.
Additional Loans are based on the lower of the estimated collection value
of the loan based on the estimated fair value of the underlying properties
or the remaining principal balance of the loan as an estimate of the fair
value of the loan is not practicable. Management does not include any
participation income in the Trust's estimated fair values, as Management
does not believe it can predict the amount or timing of realization of any
such feature with any certainty.
Based on the estimated fair value determined using these methods and
assumptions, the Trust's investments in PIMs and PIMIs had gross
unrealized gains of approximately $763,000 at December 31, 2003 and gross
unrealized gains of approximately $3,694,000 at December 31, 2002.
Continued
F-17
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
----------------------
I. Fair Value Disclosures of Financial Instruments, continued
At December 31, 2003 and 2002, the estimated fair values of the Trust's
financial instruments are as follows:
(rounded to thousands)
2003 2002
-------------------- ----------------------
Fair Carrying Fair Carrying
Value Value Value Value
------- -------- -------- --------
Cash and cash equivalents $ 5,454 $ 5,454 $ 20,451 $ 20,451
MBS 3,931 3,931 11,521 11,521
PIMs and PIMIs:
PIMs 7,964 7,866 38,345 36,818
Insured mortgages 27,068 26,403 51,808 49,641
Additional loans 6,880 6,880 11,754 11,754
------- ------- -------- --------
Total $51,297 $50,534 $133,879 $130,185
======= ======= ======== ========
F-18
KRUPP GOVERNMENT INCOME TRUST II
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
----------------------
2003
Balance at Charged to Balance at
Beginning costs and end of
Description of period expenses Reversals period
- ----------- ------------ ------------ ------------ ------------
Valuation
Allowance $ -- $ -- $ -- $ --
============ ============ ============ ============
2002
Balance at Charged to Balance at
Beginning costs and end of
Description of period expenses Reversals period
- ----------- ------------ ------------ ------------ ------------
Valuation
Allowance $ 500,000 $ -- $ (500,000) $ --
============ ============ ============ ============
2001
Balance at Charged to Balance at
Beginning costs and end of
Description of period expenses Reversals period
- ----------- ------------ ------------ ------------ ------------
Valuation
Allowance $ 2,000,000 $ -- $ (1,500,000) $ 500,000
============ ============ ============ ============
F-19
KRUPP GOVERNMENT INCOME TRUST II
SUPPLEMENTARY DATA
SELECTED QUARTERLY FINANCIAL DATA
(Unaudited)
----------------------
For the Quarter Ended
---------------------
March 31, June 30, September 30, December 31,
2003 2003 2003 2003
------------- -------------- -------------- -------------
Total revenues $ 3,968,248 $ 1,586,724 $ 4,396,051 $ 1,546,921
============= ============== ============== =============
Net income $ 3,238,642 $ 1,066,208 $ 3,708,924 $ 771,665
============= ============== ============== =============
Earnings per Share $ .18 $ .05 $ .21 $ .04
============= ============== ============== =============
For the Quarter Ended
---------------------
March 31, June 30, September 30, December 31,
2002 2002 2002 2002
------------- -------------- -------------- -------------
Total revenues $ 7,126,266 $ 2,200,656 $ 2,680,751 $ 5,350,966
============= ============== ============== =============
Net income $ 5,944,486 $ 1,530,728 $ 1,959,918 $ 4,602,250
============= ============== ============== =============
Earnings per Share $ .32 $ .09 $ .10 $ .25
============= ============== ============== =============
F-20