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.
A REIT is a legal entity that holds real estate interests and receives a deduction for dividends paid to its shareholders for federal income tax purposes. The Trust has elected to be treated as a real estate investment trust ("REIT"), under the Internal Revenue Code of 1986, as amended. Financial information concerning the Trust and our business segment for each of the fiscal years ended December 31, 2004, December 31, 2003 and December 31, 2002 is included in the consolidated financial statements and the notes thereto in "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" in PART II, ITEM 8. 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 remaining two PIMIs may be realized by the Trust through repayment or sale as early as ten years from the closing dates of the permanent loans. On December 14, 2004, the Trust issued a call to the borrower to accelerate the Martin's Landing Apartments PIMI
and on February 28, 2005, the Trust received a prepayment of the Martin's Landing Apartments PIMI. If the remaining PIMI is sold prior to December 31, 2030, the Trust will dissolve.
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 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, 2004, no personnel were directly employed by the Trust.
ITEM 2.
ITEM 2. PROPERTIES
None.
ITEM 3.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Currently there is no established public trading market for the Shares.
The number of investors holding Shares as of December 31, 2004 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 the first quarter of 2004 and $0.05 for the second, third and fourth quarter of 2004 and $0.14 per share for each quarter of 2003.
The Trust has no compensation plans or individual compensation arrangements under which its equity securities are authorized for issuance.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The table on the following page 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
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
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, 2004, the Trust had liquidity consisting of cash and cash equivalents of approximately $4.2 million, as well as the cash inflows provided by the remaining PIMIs, MBS and cash and cash equivalents. The Trust may also receive additional cash flow from the participation features of its 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 $919,000, which represents the current quarterly dividend rate of $0.05 per share. Dividends are funded by interest income received on the PIMIs, MBS and cash and cash equivalents, net of operating expenses, and the principal collections received on its 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 $0.05 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.
In addition to providing guaranteed or insured monthly principal and interest payments from the insured first mortgage or Fannie Mae MBS portion of a PIMI, the Trust's investments in the 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, 2004, the Trust received both installments of Additional Loan interest due in 2004 from its PIMI investments.
The Trust received participation interest based on cash flow generated by property operations from three of its investments during the year ended December 31, 2004. The Lakes paid $70,752, Martin's Landing paid $65,742 and Mill Pond II paid $135,547.
On December 14, 2004, the Trust issued a call to the borrower to accelerate the Martin's Landing Apartments PIMI of the $9,560,996 First Mortgage and the $2,280,000 Additional Loan. Both the First Mortgage Note and the Subordinate Note were due to mature on September 30, 2005 under the terms of the loan documents. On February 28, 2005, the Trust received a prepayment of the Martin's Landing Apartments Additional Loan note. The Trust received $2,280,000 of Additional Loan principal, in addition, the Trust received $1,742,959 of interest, which included $1,639,221 of Participating Appreciation Interest, $79,800 of unpaid Additional Loan interest and $23,938 of Participating Income Interest. In the first quarter of 2005 the Trust expects to receive the remaining outstanding balance of the Martin's Landing Apartments PIMI First Mortgage Note of $9,523,897 and will pay a special dividend of $0.74 in first quarter of 2005.
On December 3, 2004, the Trust received a prepayment of the Mill Pond II Apartments PIMI for $7,853,101. The Trust also received a prepayment premium of $65,700. In addition, the Trust received $135,547 of participation interest. On December 16, 2004, the Trust paid a special dividend of $0.44 per share from the proceeds received.
In 2004, the overall mortgage investments of the Trust decreased by approximately 21%. In addition, due to the cumulative prepayments since inception through December 31, 2004, the Trust has approximately 11% of its original mortgage investments remaining.
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 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 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.
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 PIMIs. During the first five years of the investment, borrowers are generally prohibited from repayment. During the second five years, the PIMI borrowers can prepay the insured or guaranteed 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 PIMI results from the foreclosure on the underlying property, an insurance claim or under a guarantee, 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 either of the remaining PIMIs to be subject to any foreclosure action or an insurance or guarantee claims.
The Trust has exercised its option to call one of the remaining PIMIs by accelerating its maturity. The Trust will have the option to call the last PIMI during 2005 in accordance with the loan documents. The Advisor will determine the merits of exercising the call option for the remaining 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 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 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") 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 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.
Prepaid fees and expenses represent prepaid acquisition fees and expenses and prepaid participation servicing fees paid for the acquisition and servicing of 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 PIMI, any unamortized acquisition fees and expenses and unamortized participation servicing fees related to such loan are expensed.
Off-Balance Sheet Arrangements
None
Contractual Obligations
None
ITEM 7A.
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, 2004, the Trust's investments also include cash and cash equivalents of approximately $3.5 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, 2004, the Trust's 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 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 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.
(1) The methodology used by the Trust to estimate the fair value of each class of financial instrument is described in Note J 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 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, 2004, 2003, and 2002.
The Trust's net income decreased in 2004 when compared to 2003 primarily due to decreases in basic interest on PIMs and PIMIs, participation interest and MBS interest income. This decrease was partially offset by a decrease in amortization expense and by the operating expense limitation adjustment (As described in Note F of Appendix A). Basic interest on PIMs and PIMIs decreased primarily due to the Rivergreens II, Crossings Village and Fountains payoffs in 2003. Participation income decreased primarily due to the payoffs of the Oasis at Springtree and Crossings Village Additional Loans in 2003. The decrease in MBS interest income is due to the Oasis at Springtree and the Willows MBS payoffs in 2003 and on-going single-family MBS principal collections. Amortization expense decreased as a result of the full amortization of the remaining prepaid fees and expenses on the PIM and PIMI prepayments in 2003.
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.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Appendix A to this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
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.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
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:
* Independent Trustee
Douglas Krupp co-founded and serves as Chairman and Chief Executive Officer of The Berkshire Group, an integrated real estate financial services firm which over the years has been engaged in real estate acquisitions, property management, investment sponsorship, venture capital investing, mortgage banking, financial management and ownership of operating companies through private equity investments. Mr. Krupp has held the position of Chairman and previously, 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. Mr. Krupp is a regional board member of the Anti-Defamation League. Mr. Krupp is a graduate of Bryant College where he 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.
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 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.
Wayne Zarozny is Vice President and Corporate Controller of The Berkshire Group. Mr. Zarozny has held several positions within The Berkshire Group since joining the company in 1986 and is currently responsible for accounting, financial reporting and treasury activities. Before joining The Berkshire Group, he was an audit supervisor for Pannell Kerr Forster International and on the audit staff of Deloitte, Haskins and Sells in Boston. He received a Bachelor of Science degree from Bryant College, a Master of Business Administration degree from Clark University 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 is deemed to be Executive Officer of the registrant:
George Krupp (age 60) 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, 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.
The Trust has a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions.
ITEM 11.
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 2004.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of January 28, 2005, 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 an affiliate of 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.
(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) The Douglas Krupp 1980 Family Trust owns 50% of the limited partnership interests in The Krupp Family Limited Partnership - 94, and by virtue of such interest, The Douglas Krupp 1980 Family Trust may be deemed to beneficially own the shares of GIT II owned by BIR-OP. The sole trustee of The Douglas Krupp 1980 Family Trust is Robert M. Dombroff. The trustee controls the power to dispose of the assets of the trust and thus may be deemed to beneficially own the shares of GIT II owned by BIR-OP; however, the trustee disclaims beneficial ownership of all of those shares that are or may be deemed to be beneficially owned by Douglas Krupp or George D. Krupp.
(6) 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 interest, The George Krupp 1980 Family Trust may be deemed to beneficially own the shares of GIT II owned by BIR-OP. The sole trustee of The George Krupp 1980 Family Trust is Robert M. Dombroff. The trustee controls the power to dispose of the assets of the trust and thus may be deemed to beneficially own the shares of GIT II owned by BIR-OP; however, the trustee disclaims beneficial ownership of all of those shares that are or may be deemed to be beneficially owned by Douglas Krupp or George D. Krupp.
(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 28, 2005.
ITEM 13.
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 2004, the Trust incurred $323,670 and paid $164,961 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 2004, The Berkshire Companies Limited Partnership and Berkshire Mortgage Finance Limited Partnership, affiliates of the Advisor, received a total of $363,401 in reimbursements from the Trust.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
On the following page is a summary of the fees billed to the Trust by PricewaterhouseCoopers LLP for professional services rendered for the fiscal years ended December 31, 2004 and December 31, 2003:
Fee Category Fiscal 2004 Fees Fiscal 2003 Fees - ------------ ---------------- ---------------- Audit Fees $ 39,960 $ 37,000 Tax Fees 3,675 3,675 ---------- ----------
Total Fees $ 43,635 $ 40,675 ========== ==========
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 2004.
Tax Fees. Consists of fees billed for professional services for tax compliance.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this report:
(a) 1. Financial Statements - see Index to Financial Statements and Supplementary Data included under Item 8, Appendix A, on page of this report.
2. Financial Statement Schedules - see Index to Financial Statements and Supplementary Data included under Item 8, Appendix A, on page 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.
3. Exhibits - see Exhibit index below.
(b) 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)].*
(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)].*
(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
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 16th day of March, 2005.
KRUPP GOVERNMENT INCOME TRUST II
By: /s/ Douglas Krupp ------------------------------------------ Douglas Krupp, Chairman of the Board of Trustees and a Trustee of Krupp Government Income Trust II
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 16th day of March, 2005.
Signatures Title(s)
/s/ Douglas Krupp Chairman of the Board of Trustees and a Trustee - ------------------------ of Krupp Government Income Trust II Douglas Krupp
/s/ Wayne Zarozny Treasurer and Chief Accounting Officer of - ------------------------ Krupp Government Income Trust II Wayne Zarozny
/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
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, 2004
KRUPP GOVERNMENT INCOME TRUST II
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-----------------------------------
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.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-----------------------------------
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, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards 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 4, 2005
KRUPP GOVERNMENT INCOME TRUST II
BALANCE SHEETS
December 31, 2004 and 2003
---------------------------
ASSETS
The accompanying notes are an integral part of the financial statements.
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the Years Ended December 31, 2004, 2003, and 2002
------------------
The accompanying notes are an integral part of the financial statements.
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2004, 2003 and 2002
---------------------------
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.
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2004, 2003 and 2002
-------------------
The accompanying notes are an integral part of the financial statements.
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 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
Continued
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
-------------------
B. Significant Accounting Policies, continued
PIMs and PIMIs, continued
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.
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 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 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
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
-------------------
C. PIMIs
The Trust had investments in two PIMIs at December 31, 2004 and 2003 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 tenth anniversary of the closing date of the Fannie Mae PIMIs, generally 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
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 December 14, 2004, the Trust issued a call to the borrower to accelerate the Martin's Landing Apartments PIMI of the $9,560,996 First Mortgage and the $2,280,000 Additional Loan. Both the First Mortgage Note and the Subordinate Note were due to mature on September 30, 2005 under the terms of the loan documents. On February 28, 2005, the Trust received a prepayment of the Martin's Landing Apartments Additional Loan note. The Trust received $2,280,000 of Additional Loan principal, in addition, the Trust received $1,742,959 of interest, which included $1,639,221 of Participating Appreciation Interest, $79,800 of unpaid Additional Loan interest and $23,938 of Participating Income Interest. In the first quarter of 2005 the Trust expects to receive the remaining outstanding balance of the Martin's Landing Apartments PIMI First Mortgage Note of $9,523,897 and will pay a special dividend of $0.74 in first quarter of 2005.
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.
At December 31, 2004 and 2003 there are no PIMIs within the Trust's portfolio that are delinquent as to principal or interest.
The Trust's investments in PIMIs consists of the following at December 31, 2004 and 2003:
Continued
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
-------------------
C. PIMIs, continued
(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 $25,889,150.
(c) The aggregate cost for federal income tax purposes is $6,880,000.
Impaired Additional Loans
As a result of the Windmill Lakes Additional Loan payoff in March 2002, the remaining impairment provision of $500,000 was reversed.
Reconciliations of activity for 2004, 2003 and 2002 are as follows:
Insured Mortgages
Continued
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
-------------------
C. PIMIs, continued
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.
D. PIMS
At December 31, 2004 the Trust had no investments in PIMs. On December 31, 2003 the Trust had an investment in one PIM. The Trust's PIMs consisted 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").
On December 3, 2004, the Trust received a prepayment of the Mill Pond II Apartments PIM for $7,853,101. The Trust also received a prepayment penalty of $65,700. In addition, the Trust received $135,547 of participation interest. On December 16, 2004, the Trust paid a special dividend of $0.44 per share from the proceeds received.
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.
At December 31, 2004 and 2003 there are no insured mortgage loans within the Trust's portfolio that are delinquent of principal or interest.
The Trust's PIMs consisted of the following at December 31, 2004 and 2003:
PIM Original Amount Balance Outstanding at December 31, - ------------- --------------- ----------------------------------- 2004 2003 ---- ---- FHA Mill Ponds II $8,245,300 $ -- $7,865,941 ---------- --------- ----------
Total $8,245,300 $ -- $7,865,941 ========== ========= ========== (a)
(a) There is no aggregate cost for federal income tax purposes.
Continued
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
-------------------
D. PIMs, continued
Reconciliation of activity for 2004, 2003, and 2002 are as follows:
E. Mortgage Backed Securities
At December 31, 2004, the Trust's MBS portfolio had an amortized cost of $ 2,516,943 and gross unrealized gains of $138,663. At December 31, 2003 the Trust's MBS portfolio had an amortized cost of $3,795,388 and gross unrealized gains of $135,556. The MBS have maturities ranging from 2008 to 2031. Management reviews the MBS portfolio to determine if impairment indicators exist. If an other than temporary impairment in carrying value exists, a provision to write down the asset to fair value will be recorded in the Trust's financial statements
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.
The Trust's MBS portfolio had the following contractual maturities as of December 31, 2004:
Maturity Date Fair Value Unrealized Gain ------------- ---------- ---------------
2004 - 2008 $ 10,495 $ 234 2009 - 2013 44,503 2 ,069 2014 - 2031 2,600,608 136,360 ---------- ----------
Total $2,655,606 $ 138,663 ========== ==========
F. Operating Expense Limitation
Per Article VI, Section 5 of the Declaration of Trust, the total annual operating expenses of the Trust may not exceed the greater of 2% of the average invested assets of the Trust or 25% of the Trust's net income. These tests are calculated each quarter by the Advisor based on the prior twelve months of activity. In order for the Trust to be in compliance with this requirement, the Advisor refunded $170,944 of the Trust's operating expenses for the twelve months ended September 30, 2004 on February 23, 2005.
Continued
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
-------------------
G. 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.
H. 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. During 2004, the Trust incurred $323,670 and paid $164,961 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. 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, 2004, 2003 and 2002 these fees totaled $16,666, $20,070 and $16,083, respectively.
I. Federal Income Taxes
The reconciliation of the income reported in the accompanying statement of income with the income reported in the Trust's 2004 federal income tax return follows:
The Trust paid dividends of $ 0.73 per share during 2004 which represents approximately $0.12 from ordinary income and $0.61 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 $2,260,000 and $2,433,000 at December 31, 2004 and 2003, respectively. The basis of the Trust's liabilities for financial reporting purposes were the same as its tax basis at December 31, 2004 and 2003.
Continued
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS, Continued
-------------------
J. 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 $139,000 at December 31, 2004 and gross unrealized gains of approximately $136,000 at December 31, 2003.
PIMs and PIMIs
There is no established trading market for these investments. Management estimates the fair value of 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 PIMIs had gross unrealized gains of approximately $653,000 at December 31, 2004 and gross unrealized gains of approximately $763,000 at December 31, 2003.
At December 31, 2004 and 2003, the estimated fair values of the Trust's financial instruments are as follows:
KRUPP GOVERNMENT INCOME TRUST II SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
KRUPP GOVERNMENT INCOME TRUST II SUPPLEMENTARY DATA SELECTED QUARTERLY FINANCIAL DATA (Unaudited)