-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NTALR2Xkhw5PXVCLjKHKFJTgACxWqndAfjq57HlDAkBwPLSNvktEUfGi5v5syCwY 5OxtmomloGHy0axl2Nbyaw== 0000773337-97-000003.txt : 19970808 0000773337-97-000003.hdr.sgml : 19970808 ACCESSION NUMBER: 0000773337-97-000003 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970807 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CENTENNIAL MORTGAGE INCOME FUND II CENTRAL INDEX KEY: 0000773337 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE [6500] IRS NUMBER: 330112106 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-15448 FILM NUMBER: 97653422 BUSINESS ADDRESS: STREET 1: 1540 S LEWIS STREET CITY: ANAHEIM STATE: CA ZIP: 92805 BUSINESS PHONE: 7145028484225 MAIL ADDRESS: STREET 2: 1540 S LEWIS STREET CITY: ANAHEIM STATE: CA ZIP: 92805 10-K/A 1 CENTENNIAL MORTGAGE INCOME FUND II FORM 10-K/A SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from N/A to N/A Commission File Number: 0-15448 CENTENNIAL MORTGAGE INCOME FUND II (Exact name of registrant as specified in its charter) California 33-0112106 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1540 South Lewis Street, Anaheim, California 92805 (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: (714)502-8484 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Limited Partnership Units (Title of Class) 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 file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO Indicate by check mark whether if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, 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. YES X NO This report includes a total of 76 pages. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. General Net loss and loss per limited partnership unit were $(1,515,000) and $(51.99) for the year ended December 31, 1996 down from $(2,377,000) and $(81.57) in 1995 and $(2,243,000) and $(76.97) in 1994. The loss in 1996 is primarily the result of the losses in unconsolidated investees, an increase in expenses associated with non-operating real estate owned and an increase in general and administrative expenses. The loss in 1995 is primarily due to losses in unconsolidated investees and a decrease in income from operations of real estate owned. The loss in 1994 is primarily the result of the provision for possible losses and losses in unconsolidated investees, a decrease in interest income and income from operations of real estate owned offset by a decrease in operating expenses from operations of real estate owned and a decrease in interest expense. Liquidity and Capital Resources At December 31, 1996, the Partnership had $261,000 in unrestricted cash and interest-bearing deposits. Additional sources of funds are expected to be from the sale of real estate owned. Future operations of real estate owned are not expected to be a significant source of funds. As of December 31, 1996, all real estate owned is classified as held for sale and the Partnership was currently marketing $11,316,000 in real estate owned. As of December 31, 1996, the Partnership had no unfunded loan commitments to nonaffiliates. The Partnership funded advances on loans to affiliates during 1996 totaling $336,000, received principal payoffs and paydowns on loans from nonaffiliates totaling $7,000 and received principal paydowns on loans from affiliates totaling $141,000. During 1996, the Partnership funded $2,000 of capital expenditures for real estate owned. The Partnership's notes payable commitments for 1997 consist of interest and non-balloon principal payments due of approximately $58,000. In addition to the note payable commitments, the Partnership's principal capital requirements include: i) property taxes and bonds on real estate owned of approximately $541,000 payable and delinquent in 1997, and ii) selling, general and administrative costs. Property taxes delinquent at December 31, 1996 have been accrued at December 31, 1996. The Partnership can apply for a 5 year redemption plan on a portion of the property taxes due in 1997 to ease liquidity constraints if necessary. These commitments are expected to be paid from existing cash balances and the sale of real estate owned. The Partnership has entered into contracts to sell all of its proposed marina and condominium project in Redwood City and a portion of its 45 acre project in Sacramento and has been negotiating with several other buyers on other projects. All of these potential transactions are subject to numerous contingencies and uncertainties and there is no assurance that any of them will ultimately close escrow. The Partnership expects to be able to sell this real estate owned to meet liquidity needs. The Partnership is continuously evaluating various alternative strategies for liquidating its real estate assets. These alternative strategies include the potential joint venture and/or build out of certain of the Partnership's properties in order to increase their marketability and maximize the return to the limited partners. In the event the Partnership decides to implement some of these strategies, it may require the reinvestment of proceeds received from the payoff of existing loans and/or the sale of other real estate assets. The decision to invest additional cash in existing assets will only be made if, based on management's best judgment at the time, there is a clear indication that such investment will generate a greater return to the limited partners than any other strategies available to the Partnership. During 1995, the Partnership, through its 50 percent owned corporation LCR Development, Inc., ("LCR") entered into a joint venture agreement with Home Devco, Inc., ("Home Devco"), an affiliated entity, entitled Silverwood Homes ("Silverwood"). For further information see note 5 of Notes to Consolidated Financial Statements. Effective with the third quarter of 1991, the Partnership suspended making any cash distributions to partners, due to a decline in liquidity and the uncertainty of the cash requirements for existing and potential real estate owned. Beginning with the fourth quarter of 1992, the Partnership entered its repayment stage and cash proceeds from mortgage investments are no longer available for reinvestment by the Partnership. Management believes that current and projected liquidity is sufficient to fund operating expenses and to meet the contractual obligations and cash flow operating requirements of the Partnership for 1997. However, the Partnership needs to improve liquidity through the sale of real estate owned in order to allocate funds to improve and to fulfill the operating requirements of the remaining real estate owned by the Partnership on a long-term basis. Results of Operations Due to the downturn in the real estate industry in California and its impact on the Partnership's borrowers, the Partnership's loans to nonaffiliates have been converted into real estate owned through foreclosures. As a result, interest income on loans to nonaffiliates, including fees, decreased substantially during 1996, 1995 and 1994. Interest income on loans to nonaffiliates, including fees, decreased to $21,000 in 1996 from $42,000 in 1995 and $96,000 in 1994. Interest income on loans to nonaffiliates decreased in 1996, 1995 and 1994 primarily due to payoffs of existing loans. Interest income on loans to affiliates, including fees was $81,000 for 1996 and $52,000 for 1995 related to the Silverwood joint venture. There was no interest income on loans to affiliates for 1994 due to the fact that there were no loans receivable from unconsolidated investees in 1994. Loans on "nonaccrual" refers to loans upon which the Partnership is no longer accruing interest. Management's policy is to cease accruing interest on loans when collection of interest and/or principal payments has become doubtful. There were no loans on nonaccrual, other than loans to affiliates, as of December 31, 1996, 1995 and 1994. The real estate owned balance before allowance for possible losses at December 31, 1996, 1995 and 1994 was $11,316,000, $11,314,000 and $11,284,000, respectively. During 1995 and 1994, the Partnership accounted for foreclosed assets using the American Institute of Certified Public Accountants Statement of Position 92-3 ("SOP 92-3"), "Accounting for Foreclosed Assets". SOP 92-3 indicated that foreclosed assets were presumed held for sale and not for the production of income. Accordingly, foreclosed assets held for sale were carried at the lower of cost or fair value minus estimated costs to sell. The cost of such assets at the time of foreclosure was the fair value of the asset foreclosed. Immediately after foreclosure, a valuation allowance was recognized for estimated costs to sell through a charge to operations. All of the Partnership's real estate owned was presumed held for sale. Effective January 1, 1996, the Partnership adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"). SFAS 121 supersedes SOP 92-3 and also requires that long-lived assets to be disposed of be reported at the lower of carrying amount or fair value less cost to sell. An impairment loss shall be measured as the amount by which the carrying amount of the asset exceeds the fair value of the assets less costs to sell. SFAS 121 requires that assets to be disposed of not be depreciated while they are held for disposal. All of the Partnership's real estate owned is presumed held for sale. The adoption of SFAS 121 did not have a significant impact on the Partnership's financial statements. The following sections entitled Nonaccrual Loans and Other Loans to Affiliates and Real Estate Owned provide a detailed analysis of these assets. Nonaccrual Loans and Other Loans to Affiliates Loans on nonaccrual status during the year ended December 31, 1996 are summarized below: During 1994, the Partnership converted a 50 percent participation in a note secured by a second trust deed into a 50 percent participation in a $2,115,000 unsecured note representing a workout loan due from LCR, an affiliate. This loan and an additional loan funded by Centennial Mortgage Income Fund ("CMIF") reflect the majority of the cost basis of lots contributed to Silverwood. LCR's only source of repayment of this note is proceeds from the sale of the fully developed lots. Management has estimated the proceeds for repayment of this note to be less than the original principal balance of the loan. As a result, the loan has been placed on nonaccrual. The participating principal balance and nonaccrued interest balances at December 31, 1996 are $1,059,000 and $241,000, respectively. As discussed in note 5 of Notes to Consolidated Financial Statements, the Partnership has reduced the carrying value of this note by $1,059,000, a portion of its share of losses from this unconsolidated investee. During 1994 and 1995, LCR evaluated various alternative strategies for liquidating its investment in the 179 lots in Lancaster. During 1994, LCR determined that its best course of action appeared to be the full-scale buildout and sale of single- family homes since the market for finished lots had fallen so significantly. LCR obtained construction financing commitments from CMIF and the Partnership and entered into a joint venture agreement entitled Silverwood with Home Devco to construct and sell single-family homes at the project. The joint venture began constructing a model home complex at the project in June 1995. Construction commenced in September 1995 on Phase I at the project. At December 31, 1996, the Partnership holds a 50 percent participation in three notes due from Silverwood consisting of a land development loan, a model home loan and a home construction loan with a combined disbursed balance of $1,301,000. The Partnership's disbursed balance of the $3,265,700 development loan at December 31, 1996 is $771,000. The Partnership had applied $252,000 of cumulative losses from unconsolidated investees against the carrying value of the note as of the same date. The Partnership's disbursed balance of the $490,000 model loan at December 31, 1996 is $245,000. The Partnership's disbursed balance of the $1,034,000 Phase I construction loan at December 31, 1996 is $285,000. Sales volumes of new homes in the Lancaster area have continued to decline since 1995 while sales prices have remained relatively flat and construction costs have increased. This has caused a further decline in the value of finished lots and a reduction in the anticipated net proceeds the Partnership expects to realize from the buildout of homes at the project. Additionally, Silverwood closed escrow on only two homes during 1996, far less than originally anticipated. As a result of these factors, LCR recorded a $2,516,000 and $1,077,000 provision for losses on real estate investments during 1995 and 1996, respectively. Real Estate Owned A description of the Partnership's principal real estate owned during the year ended December 31, 1996 follows: Office Building in San Bernardino, California The Partnership funded a loan during January 1988 with an original committed amount of $921,000 which was secured by a second trust deed on an office building comprised of 15,984 square feet of rentable space located in San Bernardino, California. The loan was provided as gap financing behind a first deed of trust in the amount of $350,000 to another financial institution. The borrower was unable to payoff the loan at maturity and the Partnership foreclosed on April 20, 1993. The Partnership restructured the note secured by the first trust deed to a more favorable term and rate. The project is 66 percent leased and the property is beginning to generate positive net operating income. The property generated net operating income of $36,000 during 1996. The property is being marketed for sale, however, due to below desirable occupancy levels, it is difficult to attract buyers. The carrying value before allowance for possible losses at December 31, 1996 was $825,000. The Partnership has recorded a $250,000 allowance for losses related to this property as of December 31, 1996. The property is encumbered by a fully amortizing note secured by a first trust deed of $143,000 which matures December 1, 1999. 45 Acres in Sacramento, California The Partnership funded a loan in 1987 with a committed amount of $4,000,000 secured by a first trust deed on 44.52 acres in Sacramento, California. The loan was provided for the development of offsite improvements. The maturity date was February 1, 1991. The borrower was unable to obtain construction financing and bring interest current. The Partnership accepted a grant deed on the property on March 10, 1992. The property is zoned for multi-family and light industrial use. A portion of the property is adjacent to Highway 99 and has good freeway visibility. The property is listed for sale and during 1995 and 1996 there was a significant increase in activity. The Partnership is in the process of rezoning and subdividing portions of the property to facilitate one escrow on a 6.5 acre portion of the property without freeway visibility. This portion was originally placed in escrow during 1995. However, due to the buyer's inability to obtain financing, the escrow fell through. During the first quarter of 1996, this escrow was reopened. The Partnership is not expecting to realize any material gains or losses related to this potential sale and there is no assurance that the escrow will actually close. At December 31, 1996, the carrying value before allowance for possible losses was $4,128,000. The Partnership has recorded a $584,000 allowance for losses related to this property as of December 31, 1996. Proposed Marina and Condominiums in Redwood City, California On April 7, 1989, the Partnership foreclosed on a land loan located in Redwood City, California with an original committed amount of $3,487,000. The purpose of the loan was to acquire the land and provide for the planning of a 122-slip marina plus an office building and restaurant. The original maturity date of October 21, 1986 was extended to March 1, 1987. In March 1987, the borrower filed bankruptcy. The property is included in real estate owned at its carrying value before allowance for possible losses of $5,360,000. Management has obtained an extension on the 404B1 permit for the marina through March 1999. The 404B1 permit enables the owner to build the currently proposed 104-slip boat marina. The Partnership has completed approximately 70 percent of the dredging of the marina site. The property is currently in escrow for a purchase price of $4,000,000 with possible increases if certain conditions are met. Close of escrow is scheduled for December 31, 1997 with extensions to March 31, 1998. However, there is no assurance that this escrow will actually close. The Partnership has recorded a $1,651,000 allowance for losses related to this property as of December 31, 1996. 10.66 Acres in Roseville, California The Partnership funded a loan in 1990 with an original commitment of $2,779,000 secured by a second deed of trust on 982 acres in Roseville, California. The borrower failed to make the required yearly principal payment to the first and second trust deed holders. The first trust deed holder filed a notice of default for nonpayment. Management negotiated a settlement agreement to accept a 10.66 acre commercial site as payment in full for the $2,779,000 note. This property had a carrying value before allowance for possible losses at December 31, 1996 of $1,003,000, and has no additional debt. This area has seen an increase in residential development during 1995 and 1996 which has increased interest in this property. Management is marketing the property for sale and is currently negotiating with a buyer for a portion of the property. The Partnership has recorded a $60,000 allowance for losses related to this property as of December 31, 1996. Interest on Interest-Bearing Deposits Interest on interest-bearing deposits was $21,000 in 1996, $49,000 in 1995 and $38,000 in 1994. The decrease in interest on interest-bearing deposits in 1996 is primarily the result of lower cash balances due to a lack of the sale of real estate owned. The increase in interest on interest-bearing deposits in 1995 is primarily the result of an increase in average cash balances. Interest on interest-bearing deposits represents interest earned on Partnership funds invested, for liquidity, in time certificate and money market deposits. Income from Operations of Real Estate Owned Income from operations of real estate owned consists of operating revenues of $127,000 in 1996, $134,000 in 1995 and $243,000 in 1994. The 1996 and 1995 revenues are from the office building in San Bernardino. The 1994 revenues are from the office building in San Bernardino and eight months of revenues from a lube center and car wash in San Marcos. Provision for Possible Losses The provision for possible losses was $199,000 in 1995 and $1,268,000 in 1994. There was no provision for possible losses recorded in 1996. The 1995 provision relates to loans receivable from an affiliate secured by timeshare interests and the office building in San Bernardino. The 1994 provision relates to the proposed marina and condominiums in Redwood City offset by a decrease in the provision for 128 lots in Redlands, the lube center and car wash in San Marcos and the office building in San Bernardino. Management believes that the allowance for possible losses at December 31, 1996 is adequate to absorb the known risks in the Partnership's loan and real estate owned portfolios. Other Expenses The Partnership has invested in corporations in which it has less than a majority ownership and accounts for these investments using the equity method. The Partnership's share of losses in these unconsolidated investees was $1,059,000 for 1996, $1,803,000 for 1995 and $408,000 for 1994. The 1996 share of losses consist primarily of provisions for losses on real estate investments recorded by LCR and BKS related to the 179 lots in Lancaster and the 283 acres in Bakersfield and additional costs related to the sale of homes in Lancaster. The 1995 share of losses also consists primarily of provisions for losses on real estate investments related to the 179 lots in Lancaster and the 283 acres in Bakersfield. The Partnership has written off its investment in BKS and its remaining net carrying value of its investment in LCR has been reduced to $1,049,000 as of December 31, 1996. Operating expenses from operations of real estate owned were $76,000 in 1996, $107,000 in 1995 and $161,000 in 1994. The decrease for 1996 is due to parking lot expenses incurred in 1995 with no similar expense in 1996. The decrease from 1994 to 1995 is due to the decrease in the number of real estate owned properties. Operating expenses from operations of real estate owned paid to affiliates were $12,000 each for 1996 and 1995 and $14,000 for 1994. The expenses consist of property management fees paid to affiliates of the general partners. Expenses associated with non-operating real estate owned were $344,000 in 1996, $289,000 in 1995 and $313,000 in 1994. The expenses relate to the proposed marina and condominiums in Redwood City, the 128 single-family lots in Redlands, the 283 acres in Bakersfield, the 179 lots in Lancaster, the 45 acres in Sacramento and the 10.66 acres in Roseville. These expenses include property taxes of $257,000, $244,000 and $305,000 for 1996, 1995 and 1994, respectively. The increase from 1995 to 1996 is due to costs incurred to facilitate the escrows on the proposed marina and condominiums in Redwood City and the 45 acres in Sacramento as well as the negotiations on the 10.66 acres in Roseville. The decrease from 1994 to 1995 is primarily due to a decrease in property tax expenses due to the decrease in real estate owned. Depreciation and amortization expense was $8,000 in 1996, $11,000 in 1995 and $13,000 in 1994 for the office building in San Bernardino and the multi-tenant industrial buildings in Moreno Valley. The decrease from 1995 to 1996 is due to fully amortized leasing commissions in 1995. Interest expense was $16,000 for 1996, $20,000 for 1995 and $156,000 for 1994. The interest expense for 1996 and 1995 relates only to the underlying debt on the office building in San Bernardino. The decrease from 1994 to 1995 is the result of the reduction of the debt on the 128 lots in Redlands, the lube center and car wash in San Marcos and the multi-tenant industrial buildings in Moreno Valley. The loss on sale of real estate owned totaled $64,000 for 1994. There was no comparable expense for 1996 and 1995. The 1994 loss was from the sale of the lube center and car wash in San Marcos. General and administrative expenses, affiliates increased to $173,000 in 1996 from $123,000 in 1995 and $151,000 in 1994. These expenses are primarily salary allocation reimbursements paid to affiliates for the management of the Partnership's assets. The increase for 1996 is primarily due to a $33,000 change in billing methodology from mortgage investment servicing fees to salary allocations. The decrease for 1995 is due to no extraordinary payment of vacation benefits which had accrued but not vested in prior periods and were paid in 1994 upon replacement of the corporate general partner. General and administrative expenses, nonaffiliates increased to $78,000 in 1996 from $59,000 in 1995 and $87,000 in 1994. The increase for 1996 is primarily due to increased investor reporting expenses and moving expenses. The decrease for 1995 is due primarily to a decrease in administrative expenses associated with real estate owned. Mortgage investment servicing fees paid to affiliates were $33,000 in 1995 and $41,000 in 1994. There were no mortgage investment servicing fees paid to affiliates during 1996. These fees consist of amounts paid to CC and CMIF, Inc., for servicing the Partnership's loan portfolio. During 1996, the Partnership no longer incurs mortgage investment servicing fees for servicing the Partnership's real estate owned portfolio. The decreases for 1995 and 1994 are primarily due to the decreases in size of the Partnership's loan portfolio. 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. CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A California Limited Partnership By: CENTENNIAL CORPORATION General Partner /s/Joel H. Miner _________________________________ Joel H. Miner Chief Financial Officer August 4, 1997 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership ANNUAL REPORT Form 10-K/A Consolidated Financial Statements Items 8, 14(a)(1) and 14(a)(2) December 31, 1996, 1995 and 1994 (With Independent Auditors' Report Thereon) CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Items 8, 14(a)(1) and 14(a)(2) Index to Consolidated Financial Statements and Schedules Consolidated Financial Statements Page Independent Auditors' Report............................ F-3 Consolidated Balance Sheets -- December 31, 1996 and 1995.............................. F-4 Consolidated Statements of Operations -- Years ended December 31, 1996, 1995 and 1994............ F-6 Consolidated Statements of Partners' Equity -- Years ended December 31, 1996, 1995 and 1994............ F-8 Consolidated Statements of Cash Flows -- Years ended December 31, 1996, 1995 and 1994............ F-9 Notes to Consolidated Financial Statements.............. F-15 Schedules Schedule III - Consolidated Real Estate Owned and Accumulated Depreciation and Amortization........... F-39 Schedule IV - Mortgage Loans on Real Estate............. F-44 All other schedules are omitted as the required information is inapplicable, or the information is presented in the consolidated financial statements or notes thereto. Exhibit 21 LCR DEVELOPMENT, INC. A California Corporation Index to Consolidated Financial Statements Consolidated Financial Statements Page Independent Auditors' Report ........................... F-49 Consolidated Balance Sheets -- December 31, 1996 and 1995.............................. F-50 F-1 Consolidated Statements of Operations -- Years ended December 31, 1996, 1995 and 1994............ F-52 Consolidated Statements of Stockholders' Equity (Deficit) Years ended December 31, 1996, 1995 and 1994............ F-53 Consolidated Statements of Cash Flows -- Years ended December 31, 1996, 1995 and 1994............ F-54 Notes to Consolidated Financial Statements.............. F-57 F-2 INDEPENDENT AUDITORS' REPORT To the General Partners Centennial Mortgage Income Fund II: We have audited the consolidated financial statements of Centennial Mortgage Income Fund II, a limited partnership, and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Centennial Mortgage Income Fund II and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG Peat Marwick LLP Orange County, California March 21, 1997 F-3 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Balance Sheets
December 31, 1996 and 1995 Assets 1996 1995 - ----------------------------------------------------------------- Cash and cash cash equivalents (note 5) $ 261,000 $ 854,000 Restricted cash 12,000 11,000 Short-term investments --- 102,000 Real estate loans receivable, earning 19,000 25,000 Real estate loans receivable from unconsolidated investees, earning (note 5) --- 1,033,000 Real estate loans receivable from unconsolidated investees, nonearning (note 5) 1,049,000 798,000 - ----------------------------------------------------------------- 1,068,000 1,856,000 Less allowance for possible loan losses (note 3) 8,000 8,000 - ----------------------------------------------------------------- Net real estate loans receivable 1,060,000 1,848,000 Real estate owned, held for sale, less accumulated depreciation of $12,000 in 1995 (notes 6 and 7) 11,316,000 11,314,000 Less allowance for possible losses on real estate owned (note 4) 2,545,000 2,545,000 - ----------------------------------------------------------------- Net real estate owned 8,771,000 8,769,000 F-4 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Balance Sheets (Continued)
December 31, 1996 and 1995 Assets 1996 1995 - ----------------------------------------------------------------- Due from affiliates 16,000 --- Other assets 12,000 21,000 - ----------------------------------------------------------------- $ 10,132,000 $ 11,605,000 ================================================================= Liabilities and Partners' Equity - ----------------------------------------------------------------- Note payable (note 7) $ 143,000 $ 185,000 Accounts payable and accrued liabilities 12,000 6,000 Interest and property taxes payable on real estate owned 283,000 203,000 Payable to affiliates (note 5) 1,000 3,000 - ----------------------------------------------------------------- Total liabilities 439,000 397,000 Partners' equity (deficit) -- 29,141 limited partnership units outstanding in 1996 and 1995 General partners (195,000) (195,000) Limited partners 9,888,000 11,403,000 - ----------------------------------------------------------------- Total partners' equity 9,693,000 11,208,000 Contingencies (note 8) - ----------------------------------------------------------------- $ 10,132,000 $ 11,605,000 =================================================================
See accompanying notes to consolidated financial statements F-5 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Statements of Operations
Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Revenue: Interest on loans to affiliates, including fees (note 5) $ 81,000 $ 52,000 $ --- Interest on loans to nonaffiliates, including fees 21,000 42,000 96,000 Interest on interest-bearing deposits (note 5) 21,000 49,000 38,000 Income from operations of real estate owned 127,000 134,000 243,000 Other 1,000 2,000 56,000 - ----------------------------------------------------------------- Total revenue 251,000 279,000 433,000 - ----------------------------------------------------------------- Expenses: Provision for possible losses (notes 3 and 4) --- 199,000 1,268,000 Share of losses in unconsolidated investees (note 5) 1,059,000 1,803,000 408,000 Operating expenses from operations of real estate owned 76,000 107,000 161,000 Operating expenses from operations of real estate owned paid to affiliates (note 5) 12,000 12,000 14,000 F-6 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Statements of Operations (Continued) Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Expenses associated with non-operating real estate owned 344,000 289,000 313,000 Depreciation and amortization expense 8,000 11,000 13,000 Interest expense 16,000 20,000 156,000 Loss on sale of real estate owned --- --- 64,000 General and administrative, affiliates (note 5) 173,000 123,000 151,000 General and administrative, nonaffiliates 78,000 59,000 87,000 Mortgage investment servicing fees paid to affiliates (note 5) --- 33,000 41,000 - ----------------------------------------------------------------- Total expenses 1,766,000 2,656,000 2,676,000 - ----------------------------------------------------------------- Net loss $(1,515,000) $(2,377,000) $(2,243,000) ================================================================= Net loss per limited partnership unit $ (51.99) $ (81.57) $ (76.97) =================================================================
See accompanying notes to consolidated financial statements F-7 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Statements of Partners' Equity
Years ended December 31, 1996, 1995 and 1994 Total General Limited Partners' Partners Partners Equity - ----------------------------------------------------------------- Balance (deficit) at December 31, 1993 $ (195,000) $ 16,023,000 $ 15,828,000 Net loss --- (2,243,000) (2,243,000) - ----------------------------------------------------------------- Balance (deficit) at December 31, 1994 (195,000) 13,780,000 13,585,000 Net loss --- (2,377,000) (2,377,000) - ----------------------------------------------------------------- Balance (deficit) at December 31, 1995 (195,000) 11,403,000 11,208,000 Net loss --- (1,515,000) (1,515,000) - ----------------------------------------------------------------- Balance (deficit) at December 31, 1996 $ (195,000) $ 9,888,000 $ 9,693,000 =================================================================
See accompanying notes to consolidated financial statements F-8 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Statements of Cash Flows Years ended December 31, 1996, 1995 and 1994
1996 1995 1994 - ----------------------------------------------------------------- Cash flows from operating activities: Net loss $ (1,515,000) $ (2,377,000) $ (2,243,000) Adjustments to reconcile net loss to net cash used in operating activities: Provision for possible losses --- 199,000 1,268,000 Amortization of unearned loan fees (1,000) --- (8,000) Depreciation and amortization expense 8,000 11,000 13,000 Interest accrued to principal on loans to affiliates (82,000) (45,000) --- Loss on sale of real estate owned, net --- --- 8,000 Equity in losses of unconsolidated investees 1,059,000 1,803,000 408,000 Changes in assets and liabilities: Decrease in accrued interest receivable --- 10,000 6,000 Increase (decrease) in other assets 1,000 (8,000) (11,000) Increase (decrease) in accounts payable and accrued liabilities 6,000 (20,000) (25,000) F-9 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Statements of Cash Flows (Continued) Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Increase in interest and property taxes payable on real estate owned 80,000 48,000 130,000 Decrease in payable to affiliates (2,000) (4,000) --- - ----------------------------------------------------------------- Net cash used in operating activities (446,000) (383,000) (454,000) - ----------------------------------------------------------------- Cash flows from investing activities: Principal collected on loans 148,000 280,000 1,016,000 Advances on loans made to customers --- --- (2,000) Advances on loans made to affiliates (336,000) (776,000) (215,000) Capital expenditures for real estate owned (2,000) (34,000) (16,000) Proceeds from sale of real estate owned --- --- 821,000 Increase in restricted cash (1,000) --- --- (Increase) decrease in short-term investments 102,000 (102,000) --- Increase in due from affiliate (16,000) --- --- - ----------------------------------------------------------------- Net cash provided by (used in) investing activities (105,000) (632,000) 1,604,000 - ----------------------------------------------------------------- F-10 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Statements of Cash Flows (Continued) Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Cash flows from financing activities: Principal payments on notes payable (42,000) (39,000) (784,000) - ----------------------------------------------------------------- Net cash used in financing activities (42,000) (39,000) (784,000) - ----------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (593,000) (1,054,000) 366,000 Cash and cash equivalents at beginning of year 854,000 1,908,000 1,542,000 - ----------------------------------------------------------------- Cash and cash equivalents at end of year $ 261,000 $ 854,000 $ 1,908,000 ================================================================= F-11 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Statements of Cash Flows (Continued) Years ended December 31, 1996, 1995 and 1994
1996 1995 1994 - ----------------------------------------------------------------- Supplemental schedule of cash flow information: Cash paid during the year for: Interest $ 16,000 $ 20,000 $ 70,000 - ----------------------------------------------------------------- Supplemental schedule of noncash investing and financing activities: Decrease in real estate owned through transfer of ownership (note 5) $ --- $ --- $ 6,449,000 Increase in real estate loans through transfer of ownership of real estate owned (note 5) --- --- 3,004,000 Decrease in allowance for possible losses on real estate owned as a result of partial charge-off upon transfer of ownership (note 5) --- --- 2,015,000 F-12 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Statements of Cash Flows (Continued) Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Decrease in notes payable through transfer of ownership (note 5) --- --- 1,105,000 Decrease in interest and property taxes payable on real estate owned through transfer of ownership (note 5) --- --- 325,000 Decrease in real estate owned through deed in lieu of foreclosure or foreclosure --- --- 5,091,000 Decrease in allowance for possible losses on loans and real estate owned as a result of partial charge-off --- 99,000 1,647,000 Decrease in other assets through deed in lieu of foreclosure or foreclosure --- --- 52,000 Decrease in notes payable through deed in lieu of foreclosure or foreclosure --- --- 3,745,000 F-13 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Consolidated Statements of Cash Flows (Continued) Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Decrease in interest and property taxes payable on real estate owned through deed in lieu of foreclosure, sale or foreclosure --- --- 288,000 Transfer of restricted cash to workout loan --- --- 501,000 Decrease in accounts payable and accrued liabilities through transfer of ownership --- --- 5,000
See accompanying notes to consolidated financial statements F-14 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Notes to Consolidated Financial Statements December 31, 1996, 1995, 1994 (1) Summary of Significant Accounting Policies Business Centennial Mortgage Income Fund II (the "Partnership") has historically invested in commercial, industrial and residential income-producing real property through mortgage investments consisting of participating first mortgage loans, other equity participation loans, construction loans, and wrap-around and other junior loans. The Partnership's underwriting policy for granting credit was to fund loans secured by first and second deeds of trust on real property. The Partnership's area of concentration is in California. In the normal course of business, the Partnership participated with other lenders in extending credit to single borrowers. The Partnership did this in an effort to decrease credit concentrations and provide a greater diversification of credit risk. As of December 31, 1996, most of the loans secured by operating properties have been repaid to the Partnership. However, during recent years, real estate market values for undeveloped land in California have declined severely. As the loans secured by undeveloped land became delinquent, the Partnership elected to foreclose on certain of these loans, thereby increasing real estate owned balances. As a result, the Partnership has become a direct investor in this real estate and intends to manage operating properties and develop raw land until such time as the Partnership is able to sell this real estate owned. The real estate owned balance before allowance for possible losses at December 31, 1994 was $11,284,000, increasing to $11,314,000 at year end 1995 and $11,316,000 at year end 1996. Beginning with the fourth quarter of 1992, the Partnership entered its repayment stage and cash proceeds from mortgage investments are no longer available for reinvestment in new loans by the Partnership. Basis of Presentation The Partnership formed several subsidiaries to own and operate certain of its real estate assets. The corporations formed were F-15 PIR Development, Inc., RSA Development, Inc., CTA Development, Inc., LCR Development, Inc., ("LCR"), and BKS Development, Inc., ("BKS"). Several of the Partnership's assets have been transferred to these new corporations, at the Partnership's cost basis, in transactions which included no cash down and the Partnership carrying 100 percent of the financing. With the exception of LCR and BKS, all of these corporations are wholly owned corporations and have been consolidated in the accompanying consolidated financial statements. All significant intercompany balances and transactions, including the aforementioned transfer, have been eliminated in consolidation. As the Partnership's ownership interest in LCR and BKS is more than 20 percent but does not exceed 50 percent, the Partnership accounts for its ownership interest using the equity method. Under the equity method of accounting, these loans are a component of the Partnership's investment in LCR and BKS, and therefore the Partnership has recorded losses by LCR and BKS as a reduction of the carrying value of these loans receivable (see note 5). Organization The Partnership was organized on July 12, 1985 in accordance with the provisions of the California Uniform Limited Partnership Act. The Partnership commenced operations in June 1986. The general partners are John B. Joseph, Ronald R. White and Centennial Corporation ("CC"), a privately-held California corporation whose stock is owned by affiliates of Ronald R. White and John B. Joseph. Centennial Capital, Inc. ("CCI"), a California corporation, wholly-owned by The Centennial Group, Inc. retired as general partner during 1994. Cash available for distribution, as defined in the Partnership Agreement, is to be distributed 95 percent to the limited partners and 5 percent to the general partners until each limited partner has received an amount equal to a 12 percent non- cumulative annual return on their adjusted invested capital (as defined in the Partnership Agreement). Thereafter, cash available for distribution is to be distributed 90 percent to the limited partners and 10 percent to the general partners. All distributions of mortgage reductions (as defined in the Partnership Agreement) shall be distributed 99 percent to the limited partners and 1 percent to the general partners, until each limited partner has received a 12 percent cumulative annual return on their adjusted invested capital, after which such amounts are to be distributed 85 percent to the limited partners F-16 and 15 percent to the general partners. These amounts may be adjusted subject to the provisions of the Partnership Agreement. In order to properly reflect the economic effect of the allocations discussed above, the Partnership has allocated financial statement net earnings and losses 95 percent to the limited partners and 5 percent to the general partners through 1992. Based upon the various terms of the Partnership Agreement, it is improbable that the general partners would be required to make any capital contributions to the Partnership in excess of their negative capital account as of December 31, 1992. Accordingly, since January 1, 1993, the Partnership has allocated 100 percent of the losses to the limited partners. Real Estate Loans and Allowance for Possible Losses Loans are reported at the principal amount outstanding, net of unearned income and the allowance for possible loan losses. Interest accrual is discontinued when, in the opinion of management, its collection is deemed doubtful. The allowance for possible loan losses is established through a provision for possible losses charged to expense. Loans are charged against the allowance for possible loan losses when management believes that the collectibility of principal is unlikely. Management believes that the allowance for possible loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Impaired Loans Effective January 1, 1995, the Partnership adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"), as amended by Statement of Financial Accounting Standards No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures" ("SFAS 118"). Under SFAS 114, a loan is impaired when it is "probable" that a creditor will be unable to collect all amounts due (i.e. both principal and interest) according to the original contractual terms of the loan agreement. The measurement of impairment may be based on (i) the present value of the expected future cash flows of the impaired loan discounted at the loan's original effective interest rate, (ii) the observable market price of the impaired loan, or (iii) the fair value of the collateral of a collateral-dependent loan. SFAS 114 does not apply to large groups of smaller balance homogeneous F-17 loans that are collectively evaluated for impairment. The adoption of SFAS 114, as amended by SFAS 118, had no material impact on the Partnership's consolidated financial statements as the Partnership's previously existing policy of measuring loan impairment was consistent with methods prescribed in these standards. The Partnership considers a loan to be impaired when based upon current information and events, it believes it is probable that the Partnership will be unable to collect all amounts due according to the contractual terms of the loan agreement. In determining impairment, the Partnership considers large non- homogeneous loans including nonaccrual loans, troubled debt restructuring and performing loans which exhibit, among other characteristics, high loan-to-value ratios, low debt-coverage ratios, or other indications that the borrowers are experiencing increased levels of financial difficulty. The Partnership bases the measurement of collateral-dependent impaired loans on the fair value of the loan's collateral. The amount by which the recorded investment of the loan exceeds the measure of the impaired loan's value is recognized by recording a valuation allowance. Real Estate Owned During 1995 and 1994, the Partnership accounted for foreclosed assets using the American Institute of Certified Public Accountants Statement of Position 92-3 ("SOP 92-3"), "Accounting for Foreclosed Assets". SOP 92-3 indicated that foreclosed assets were presumed held for sale and not for the production of income. Accordingly, foreclosed assets held for sale were carried at the lower of cost or fair value minus estimated costs to sell. The cost of such assets at the time of foreclosure was the fair value of the asset foreclosed. Immediately after foreclosure, a valuation allowance was recognized for estimated costs to sell through a charge to income. All of the Partnership's real estate owned, including insubstance foreclosures, was presumed held for sale. Effective January 1, 1996, the Partnership adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"). SFAS 121 supersedes SOP 92-3 and also requires that long-lived assets to be disposed of be reported at the lower of carrying amount or fair value less costs to sell. An impairment loss shall be measured as the amount by which the carrying amount of the asset exceeds the fair value of the assets F-18 less costs to sell. SFAS 121 requires that assets to be disposed of not be depreciated while they are held for disposal. The Partnership considered all real estate owned as held for sale during 1996 and is actively marketing all properties using third party brokers and in house sales staff. Loan Fees Origination fees and direct costs associated with lending are netted and amortized to interest income as an adjustment to yield over the respective lives of the loans using the interest method. Income Taxes Under provisions of the Internal Revenue Code and the California Revenue and Taxation Code, partnerships are generally not subject to income taxes. For tax purposes, any income or losses realized are those of the individual partners, not the Partnership. The Partnership reports certain transactions differently for tax and financial statement purposes. The following is a recap of current and cumulative temporary differences for generally accepted accounting principles ("GAAP") and taxable earnings. F-19
Current Temporary Differences Partnership Corporations Total - -------------------------------------------------------------------------------- - ---------- GAAP loss for the year ended December 31, 1996 $ (1,088,000) $ (427,000) $ (1,515,000) Provision for losses (1,300,000) --- (1,300,000) Accrued expenses not deducted under the cash basis method of accounting (119,000) 179,000 60,000 Share of losses in unconsolidated investees (897,000) --- (897,000) Carrying costs expensed for books and capitalized for tax purposes (2,000) 243,000 241,000 Depreciation --- (15,000) (15,000) - -------------------------------------------------------------------------------- - ---------- Taxable loss for the year ended December 31, 1996 $ (3,406,000) $ (20,000) $ (3,426,000) ================================================================================ ========== Taxable loss allocable to General Partner --- ================================================================================ ========== Taxable loss per limited partner unit $ (116.88) ================================================================================ ==========
F-20
December 31, 1996 - ----------------------------------------------------------------- Cumulative Temporary Differences Partnership Corporations - ----------------------------------------------------------------- Net operating loss carry forwards $ --- $ 116,000 Provision for losses 836,000 1,717,000 Accrued expenses not deducted under the cash basis --- 4,644,000 Interest income accrued for tax, not per books 92,000 --- Charge-off of loans not deducted 715,000 --- Carrying costs expensed for books and capitalized for tax purposes (2,000) 1,085,000 Depreciation --- (42,000) Share of losses in unconsolidated investees 1,314,000 --- - ----------------------------------------------------------------- Total cumulative temporary differences $ 2,955,000 $ 7,520,000 =================================================================
The cumulative temporary partnership differences shown above, which total approximately $101.00 per limited partnership unit, should reverse when the Partnership liquidates its investments. There can be no assurance that these losses will be realized as future operations of the Partnership could result in greater or lesser amounts of allocable tax losses to the limited partners. In addition, the deductibility of taxable losses is dependent upon each limited partners' individual tax position. The reversal of these differences should result in future taxable income or loss per limited partnership unit which is less than or greater than the Partnership will report for financial statement purposes. Management believes that the share of losses in unconsolidated investees is a temporary difference since the Partnership holds approximately $2.4 million in notes receivable from these investees, a portion of which could be charged to bad debt expense should these investees liquidate their single property holdings at current carrying values. F-21 In addition, as of December 31, 1996, the Partnership held approximately $12.4 million in loans receivable from the consolidated corporations. These loans have been eliminated in the Partnership's consolidated financial statements. It is anticipated that the temporary differences should reverse on the corporations' returns when the corporations liquidate their investments. If these investments are liquidated at current carrying values, the Partnership should be able to deduct bad debt expense on its tax returns in the approximate amount of the temporary differences shown above which is approximately $258.00 per limited partnership unit. The subsidiary corporations are subject to taxation and account for income taxes under Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 requires an asset and liability approach to establishing deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the corporation's assets and liabilities. No benefit for net operating losses or cumulative differences related to the corporations has been recorded in the consolidated financial statements due to the improbability of realization. Future consolidated financial statements could reflect income tax expense in the event that these corporations generate profits in excess of operating loss carryforwards available. Some of the subsidiary corporations are cash basis taxpayers. Statements of Cash Flows For purposes of reporting cash flows, cash and cash equivalents include cash and interest-bearing deposits with original maturities of three months or less. Short-term Investments Short-term investments include certificates of deposits with original maturities greater than 90 days but less than one year. Net Loss Per Limited Partnership Unit Net loss per limited partnership unit for financial statement purposes was based on 29,141 weighted average limited partnership units outstanding in 1996, 1995 and 1994. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to F-22 make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenue and expenses during the reporting period. Actual results could differ from those estimates. Depreciation and Amortization Prior to the adoption of SFAS 121 on January 1, 1996, depreciation and amortization of real estate assets was charged to expense on a straight-line basis over the estimated useful lives of the assets; 3 years for equipment and 31.5 years for buildings, or, in the case of tenant improvements, over the terms of the leases if shorter than the estimated useful lives. Revenue Recognition Revenue from rental income on real estate owned is recognized on a straight-line basis over the life of the lease when payments become due under operating leases. In 1994, the Partnership recognized losses on the sale of real estate owned. In 1995 and 1996, there were no sales of real estate owned. (2) Fair Value of Financial Instruments Statement of Financial Accounting Standard No. 107 "Disclosures About Fair Value of Financial Instruments" ("SFAS 107"), requires that the Partnership disclose estimated fair values for its financial instruments as well as the methods and significant assumptions used to estimate fair values. The following information does not purport to represent the aggregate net fair value of the Partnership. The following methods and assumptions were used by the Partnership in estimating the fair value of each class of financial instrument. Cash and Cash Equivalents The carrying amount, which is cost, is assumed to be the fair value because of the liquidity of these instruments. Short-term Investments The carrying amount is estimated to be fair value because the funds were invested at current market rates within one month of the balance sheet date. F-23 Real Estate Loans Receivable from Unconsolidated Investees - Earning and Nonearning The net carrying value of earning loans from unconsolidated investees is estimated to be fair value. These loans reprice at market rate each time the reference rate is adjusted. Note Payable The carrying value of the fixed rate note payable is estimated to be the fair value using current market rates. Accounts Payable and Accrued Liabilities, Payable to Affiliates and Interest and Property Taxes Payable Carrying value is considered to be equal to the fair value of these liabilities as they are due on demand. (3) Allowance for Possible Loan Losses
Changes in the allowance for possible loan losses are as follows: 1996 1995 1994 - ----------------------------------------------------------------- Balance at beginning of year $ 8,000 $ 8,000 $ 149,000 Loans to affiliates and nonaffiliates charged-off --- (99,000) (73,000) Provision for possible losses (reduction in provision) --- 99,000 (68,000) - ----------------------------------------------------------------- Balance at end of year $ 8,000 $ 8,000 $ 8,000 ================================================================
At December 31, 1996, the carrying value of loans that are considered to be impaired under SFAS 114 totaled $1,049,000 (all of which were on nonaccrual status). At December 31 1996, there F-24 was no allowance for possible loan losses determined in accordance with the provisions of SFAS 114, related to loans considered to be impaired under SFAS 114, recorded by the Partnership. However, as discussed in note 5, the unconsolidated investees have recorded an allowance for losses of $3,898,000 and the Partnership's proportionate share of the losses in unconsolidated investees reflects this allowance. There was a $336,000 investment in impaired loans for the year ended December 31, 1996. There was no investment in impaired loans for the year ended December 31, 1995. For the year ended December 31, 1996, the Partnership recognized $81,000 in interest income on these impaired loans. There was no interest income recognized on these impaired loans for the years ended December 31, 1995 and 1994. No cash basis income was recognized on these impaired loans for the years ended December 31, 1996, 1995 and 1994. If the loans on nonaccrual had been current throughout their terms, interest income would have increased by approximately $96,000, $379,000 and $211,000 for the years ended December 31, 1996, 1995 and 1994, respectively. (4) Allowance for Possible Losses on Real Estate Owned
Changes in the allowance for possible losses on real estate owned are as follows: 1996 1995 1994 - ----------------------------------------------------------------- Balance at beginning of year $ 2,545,000 $ 2,445,000 $ 4,698,000 Real estate owned charged-off --- --- (3,589,000) Provision for losses --- 100,000 1,336,000 - ----------------------------------------------------------------- Balance at end of year $ 2,545,000 $ 2,545,000 $ 2,445,000 =================================================================
F-25 (5) Transactions with Affiliates Under the provisions of the Partnership Agreement, CC and CMIF, Inc., an affiliate of the general partners, are entitled to receive from the Partnership mortgage investment servicing fees for loans serviced equal to an annual rate of 1/4 of 1 percent of the committed amounts to be funded by the Partnership. Under the provisions of the Partnership Agreement, the Partnership incurred $8,000 of mortgage investment servicing fees payable to CMIF, Inc. in 1994 and paid $12,000 of such fees in 1994. The Partnership incurred $33,000 of mortgage investment servicing fees payable to CC in 1995 and 1994 and paid $3,000, $30,000 and $27,000 were paid in 1996, 1995 and 1994, respectively. No mortgage investment servicing fees were incurred during 1996. Under the provisions of the Partnership Agreement, the general partners are to receive compensation for their services in supervising the affairs of the Partnership. This partnership management compensation shall be equal to 10 percent of the cash available for distribution, as defined in the Partnership Agreement. The general partners will not receive this compensation until the limited partners have received a 12 percent per annum cumulative return on their adjusted invested capital; however, the general partners are entitled to receive a minimum 5 percent interest in cash available for distribution in any year until this return has been met. Adjusted invested capital is defined as the original capital invested less distributions from mortgage reductions. Under this provision, payments to the general partners have been limited to 5 percent of cash available for distribution as the limited partners have not received their 12 percent per annum cumulative return. Under this provision of the Partnership Agreement, no distributions were paid to the general partners during 1996, 1995 or 1994. As discussed below, the Partnership owns 50 percent of the stock of two corporations which have not been consolidated in the accompanying financial statements; LCR and BKS. The balance of stock in these corporations is owned by Centennial Mortgage Income Fund ("CMIF"), an affiliate. LCR has invested in a joint venture, Silverwood Homes ("Silverwood") which is constructing homes. The Partnership has participated in making several loans to these corporations and this joint venture. Under the equity method of accounting, these loans are a component of the Partnership's investment in LCR and BKS, and therefore the Partnership has recorded losses by LCR and BKS as a reduction of the carrying value of these loans receivable. The Partnership F-26 wrote off its investment in and loan receivable from BKS during 1996 when its share of losses equaled its investment and the recovery of any of its investment became unlikely. A summary of these real estate loans receivable from unconsolidated investees as of December 31, 1996 is as follows:
Net Principal Losses Carrying Balance Offset Value - ----------------------------------------------------------------- 50 percent interest in unsecured note receivable from LCR $ 1,059,000 $ 1,059,000 $ --- 50 percent interest in development loan secured by a first trust deed from Silverwood 771,000 252,000 519,000 50 percent interest in construction loan secured by a first trust deed from Silverwood 245,000 --- 245,000 50 percent interest in construction loan secured by a first trust deed from Silverwood 285,000 --- 285,000 - ----------------------------------------------------------------- Totals $ 2,360,000 $ 1,311,000 $ 1,049,000
F-27 A summary of these real estate loans receivable from unconsolidated investees as of December 31, 1995 is as follows:
Net Principal Losses Carrying Balance Offset Value - ----------------------------------------------------------------- 50 percent interest in unsecured note receivable from LCR $ 1,059,000 $ 595,000 $ 464,000 50 percent interest in note receivable secured by a first trust deed from BKS 1,947,000 1,613,000 334,000 50 percent interest in development loan secured by a first trust deed from Silverwood 543,000 --- 543,000 50 percent interest in construction loan secured by a first trust deed from Silverwood 255,000 --- 255,000 50 percent interest in construction loan secured by a first trust deed from Silverwood 235,000 --- 235,000 - ----------------------------------------------------------------- Totals $ 4,039,000 $ 2,208,000 $ 1,831,000
In February 1994, the Partnership assigned its 50 percent interest in a construction loan secured by a second trust deed, which was participated with CMIF, to LCR in order to facilitate LCR's foreclosure of 179 lots in Lancaster, California. In anticipation of this foreclosure, LCR purchased the underlying note secured by a first trust deed on the property with funds F-28 provided by CMIF. CMIF also assigned its 50 percent interest in the construction loan secured by a second trust deed to LCR. In exchange for the assignment of the note secured by a second trust deed, the Partnership received a 50 percent interest in an unsecured note due from LCR with a principal balance of $2,115,000 as of December 31, 1996 and 1995, respectively. The Partnership has not accrued its share of interest on this note which was approximately $241,000 and $176,000 as of December 31, 1996 and 1995, respectively. LCR has entered into a joint venture agreement entitled Silverwood with Home Devco, ("Home Devco"), an affiliate of the general partners of the Partnership, to construct and sell single- family homes at the project. LCR has contributed the 179 lots to the joint venture as its initial capital contribution. As LCR has a 99.99 percent ownership interest in the joint venture, Silverwood has been consolidated with LCR and the contribution of these lots to the joint venture has no effect on the financial position of LCR. The consolidated balance sheets and statements of operations of LCR have not been consolidated in the Partnership's financial statements. The Partnership accounts for its investment in this corporation using the equity method. The following represents condensed financial information for LCR at December 31, 1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994: F-29 LCR Development, Inc. Consolidated Balance Sheets
December 31, December 31, Assets 1996 1995 - ----------------------------------------------------------------- Restricted cash $ 10,000 $ --- Real estate owned 6,492,000 5,263,000 Less allowance for losses on real estate investments 3,898,000 1,390,000 - ----------------------------------------------------------------- Net real estate owned 2,594,000 3,873,000 Organization costs 1,000 2,000 - ----------------------------------------------------------------- $ 2,605,000 $ 3,875,000 ================================================================= Liabilities and Stockholders' Equity (Deficit) - ----------------------------------------------------------------- Notes payable to affiliates: CMIF $ 4,092,000 $ 2,973,000 CMIF II 2,360,000 2,092,000 - ----------------------------------------------------------------- Total notes payable 6,452,000 5,065,000 Accounts payable and accrued liabilities 11,000 1,000 Interest payable to affiliates 845,000 509,000 Payable to affiliates 16,000 1,000 - ----------------------------------------------------------------- Total liabilities 7,324,000 5,576,000 Stockholders' equity (deficit) (4,719,000) (1,701,000) - ----------------------------------------------------------------- $ 2,605,000 $ 3,875,000 =================================================================
F-30 LCR Development, Inc. Consolidated Statement of Operations
Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Housing sales $ 233,000 $ --- $ --- Cost of housing sales 238,000 --- --- Provision for losses on real estate owned 2,516,000 1,077,000 313,000 Selling and marketing expenses 184,000 --- --- General and administrative 162,000 (3,000) 3,000 - ----------------------------------------------------------------- Operating loss (2,867,000) (1,074,000) (316,000) Interest expense 151,000 --- 313,000 - ----------------------------------------------------------------- Net (loss) $(3,018,000) $(1,074,000) $ (629,000) ================================================================= Interest not included in share of losses (336,000) (197,000) (313,000) - ----------------------------------------------------------------- Allocable net loss $(2,682,000) $ (877,000) $ (316,000) ================================================================= Share of losses recorded $(1,966,000) $ (438,000) $ (158,000) =================================================================
LCR has not accrued interest on the notes payable to the Partnership that the Partnership has classified as nonearning. Because the Partnership accounts for these loans as a component of its equity investment in LCR, any effect on the Partnership would be eliminated in consolidation. Although the Partnership owns a 50 percent interest in LCR, it holds less than 50 percent of LCR's debt. Since CMIF has loaned LCR $1,250,000 in excess of F-31 the amount the Partnership has loaned LCR, CMIF was allocated a disproportionately greater share of LCR's losses. Correspondingly, the Partnership was allocated less than 50 percent of LCR's loss during 1996.
Difference of Allocation of Share of Losses 1996 - ----------------------------------------------------------------- The Partnership's 50 percent share of LCR's stockholders' deficit at December 31, 1996 $(1,936,000) Loans receivable considered as part of the Partnership's investment 2,360,000 Disproportionate loss allocation 625,000 - ----------------------------------------------------------------- Net loans receivable $ 1,049,000 =================================================================
As discussed above, the Partnership holds 50 percent of the stock of BKS with CMIF. In 1994, the Partnership and CMIF assigned to BKS their 50 percent interest in a note receivable secured by a first trust deed on a 283 acre residential tract in Bakersfield, California. BKS foreclosed on this property on August 8, 1994. In exchange for their assignments, the Partnership and CMIF each received a 50 percent interest in a new note from BKS secured by a first trust deed on the property. The Partnership ceased accruing interest on this new note on January 1, 1995. Bonds and taxes accrued on the property increased from $1,605,000 at December 31, 1995 to $2,085,000 at December 31, 1996 and the bond holders have commenced foreclosure proceedings on the property. Management has elected to abandon the property due to the fact that land values have not increased. The balance of bonds and unpaid property taxes are now approximately equal to the value of the property. Bonds, property taxes and note payable to affiliates are nonrecourse liabilities and, therefore, the Partnership and BKS have no contingent liability in excess of the property. The Partnership has no future obligation nor risk of additional losses related to this investee. Therefore, during F-32 1996, the Partnership recorded its share of losses in connection with BKS ($343,000) which results in the Partnerships's investment in BKS, including loans, having a zero balance. The balance sheet and statements of operations of BKS have not been consolidated in the Partnership's financial statements. The Partnership accounted for its investment in this corporation using the equity method. The following represents condensed financial information for BKS at December 31, 1995 and for the years ended December 31, 1995 and 1994: BKS Development, Inc. Balance Sheet
December 31, Assets 1995 - ----------------------------------------------------------------- Cash $ 1,000 Real property 5,200,000 Less allowance for losses on real estate investments 2,693,000 - ----------------------------------------------------------------- Net real estate owned 2,507,000 - ----------------------------------------------------------------- $ 2,508,000 ================================================================= Liabilities and Stockholders' Deficit - ----------------------------------------------------------------- Bonds payable $ 899,000 Notes payable to affiliates 3,893,000 Interest and property taxes payable on real property 943,000 - ----------------------------------------------------------------- Total liabilities 5,735,000 Stockholders' deficit (3,227,000) - ----------------------------------------------------------------- $ 2,508,000 =================================================================
F-33 BKS Development, Inc. Statements of Operations
Years ended December 31, 1995 and 1994 1995 1994 - ----------------------------------------------------------------- Interest and property tax expense $ 35,000 $ 499,000 Provision for losses 2,693,000 --- General and administrative --- 2,000 - ----------------------------------------------------------------- Net income (loss) $(2,728,000) $ (501,000) ================================================================= Share of losses recorded $(1,364,000) $ (250,000) =================================================================
At the time of the foreclosures by LCR and BKS discussed above, the Partnership had accounted for its interests in the notes secured by a second trust deed and first trust deed as having been insubstance foreclosed. A summary of the effects of the foreclosures on the Partnership's balance sheet during 1994 is as follows: F-34
LCR BKS TOTAL - ----------------------------------------------------------------- Decrease in real estate owned $ 2,550,000 $ 3,899,000 $ 6,449,000 Increase in real estate loans 1,058,000 1,946,000 3,004,000 Decrease in allowance for possible losses on real estate owned 715,000 1,300,000 2,015,000 Decrease in notes payable 656,000 449,000 1,105,000 Decrease in interest and property taxes payable 121,000 204,000 325,000
The Partnership reimburses the general partner and its affiliates for expenses incurred on behalf of the Partnership for services such as salaries, legal, accounting, property management and other services. The general partners and affiliates of the general partners charged $185,000, $135,000 and $165,000 for such services in 1996, 1995 and 1994, respectively. During 1996, 1995 and 1994, the Partnership maintained interest- bearing deposits with Sunwest Bank, an affiliate of the general partners. The balances at December 31, 1996, 1995 and 1994 were $5,000, $170,000 and $54,000, respectively. Interest earned on such deposits for 1996, 1995 and 1994 was $5,000, $3,000 and $1,000, respectively. F-35 (6) Real Estate Owned
Real estate owned consists of the following: (dollars in thousands) December 31, December 31, 1996 1995 - ----------------------------------------------------------------- 1. Office building in San Bernardino, CA $ 825 $ 837 2. 45 acres in Sacramento, CA 4,128 4,126 3. Proposed marina and condominiums in Redwood City, CA 5,360 5,360 4. 10.66 acres in Roseville, CA 1,003 1,003 - ----------------------------------------------------------------- Subtotal 11,316 11,326 Less accumulated depreciation --- 12 - ----------------------------------------------------------------- Total real estate owned $ 11,316 $ 11,314 =================================================================
At December 31, 1996, the properties held for sale are presented net of accumulated depreciation as required by SFAS 121. In accordance with SFAS 121, the Partnership carries real estate owned, held for sale, at the lower of carrying amount or fair value less costs to sell. The estimated fair values were determined by using appraisals, discounted cash flows and/or other valuation techniques. The actual market price of real estate can only be determined by negotiation between independent third parties in a sales transaction and sales proceeds could differ substantially from estimated fair values. The Partnership leases its operating property under several non- cancelable operating lease agreements. Future minimum rents to be received as of December 31, 1996 are as follows: F-36
Years ending December 31, (dollars in thousands) - ----------------------------------------------------------------- 1997 $ 116 1998 55 1999 41 2000 6 - ----------------------------------------------------------------- $ 218 =================================================================
(7) Note Payable
Note payable consists of the following: (dollars in thousands) December 31, December 31, 1996 1995 - ----------------------------------------------------------------- Note payable secured by office building in San Bernardino, CA, with principal, interest and property taxes payable monthly of $6,146; interest at 9.5%, maturing December 1, 1999 $ 143 $ 185 =================================================================
F-37 Future principal payments to be paid as of December 31, 1996 are as follows:
(dollars in thousands) Years ending December 31, - ----------------------------------------------------------------- 1997 $ 46 1998 50 1999 47 - ----------------------------------------------------------------- $ 143 =================================================================
(8) Contingencies There are no material pending legal proceedings other than ordinary routine litigation incidental to the Partnership's business. Based on part of advice of legal counsel, management does not believe that the results of any of these matters will have a material impact on the Partnership's financial position or results of operations. F-38 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Schedule III Consolidated Real Estate Owned and Accumulated Depreciation and Amortization December 31, 1996
Initial Costs Capitalized Cost to Subsequent Partnership to Acquisition Real Estate Property Encumbrances Owned Improvements Carrying Costs - -------------------------------------------------------------------------------- - ---------- Office Building in San Bernardino $ 143,000 $ 800,000 $ 25,000 $ - --- 45 Acres in Sacramento --- 3,827,000 170,000 131,000 Proposed Marina and Condominiums in Redwood City --- 4,101,000 1,170,000 89,000 10.66 Acres in Roseville --- 1,000,000 3,000 - --- - -------------------------------------------------------------------------------- - ---------- $ 143,000 $ 9,728,000 $ 1,368,000 $ 220,000 ================================================================================ ========== F-39 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Schedule III Consolidated Real Estate Owned and Accumulated Depreciation and Amortization (Continued) December 31, 1996 Gross Amount at Which Carried on Books (F2) Accumulated Life On Which Real Estate Depreciation & Date Depreciation Property Owned Total Amortization Acquired Is Computed - -------------------------------------------------------------------------------- - ---------- Office Building in San Bernardino $ 825,000 $ 825,000 $ --- April 1993 (F1) 45 Acres in Sacramento 4,128,000 4,128,000 --- March 1992 None Proposed Marina and Condominiums in Redwood City 5,360,000 5,360,000 --- April 1993 None 10.66 Acres in Roseville 1,003,000 1,003,000 --- December 1992 None - ----------------------------------------------------------------- $11,316,000 $11,316,000 $ --- ================================================================= F-40 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Schedule III Consolidated Real Estate Owned and Accumulated Depreciation and Amortization (Continued) December 31, 1996 Prior to the adoption of SFAS 121, tenant improvements were depreciated over life of leases; building depreciated over 31.5 years Aggregate cost for Federal income tax purposes is $12,359,000 at December 31, 1996. Improvements re presented net of accumulated depreciation as required per SFAS 121.
F-41 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Schedule III Consolidated Real Estate Owned and Accumulated Depreciation and Amortization (Continued) December 31, 1996
The following is a summary of consolidated real estate owned for the years ended December 31, 1996, 1995, and 1994. 1996 1995 1994 - -------------------------------------------------------------------------------- - ---------- Balance at beginning of year $ 11,326,000 $ 11,292,000 $ 24,200,000 Additions during period: Improvements 2,000 34,000 16,000 Deductions during period: Real estate sold --- --- (885,000) Real estate foreclosed --- --- (8,441,000) Charge-offs --- --- (3,589,000) Other --- --- (9,000) - -------------------------------------------------------------------------------- - ---------- Balance at year end $ 11,328,000 $ 11,326,000 $ 11,292,000 ================================================================================ ==========
F-42 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Schedule III Consolidated Real Estate Owned and Accumulated Depreciation and Amortization (Continued) December 31, 1996
The following is a summary of accumulated depreciation and amortization of consolidated real estate owned for the years ended December 31, 1996, 1995, and 1994. 1996 1995 1994 - -------------------------------------------------------------------------------- - ---------- Balance at beginning of year $ 12,000 $ 8,000 $ 30,000 Additions during period: Additions --- 4,000 8,000 Deductions during period: Real estate sold --- --- (2,000) Other --- --- (28,000) - -------------------------------------------------------------------------------- - ---------- Balance at year end $ 12,000 $ 12,000 $ 8,000 ================================================================================ =========
See accompanying independent auditors' report. F-43 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Schedule IV
Mortgage Loans on Real Estate December 31, 1996 Interest Final Periodic Description Rate Maturity Date Payment Terms - -------------------------------------------------------------------------------- - ---------- Note secured by: P + I monthly Timeshare Interests Various payment of Oxnard, CA 12.25 - 13.9% fixed Various $2,149.35 50 percent interest in unsecured note related to P & I due at 177 lots in Lancaster, CA 7.75% fixed December 1, 1997 maturity 50 percent interest in First Trust Deed on P & I due at 166 lots in Lancaster, CA Prime + 1% August 1, 1997 maturity 50 percent interest in 1st T.D. on four single family P & I due at homes in Lancaster, CA Prime + 1% July 1, 1998 maturity 50 percent interest in 1st T.D. on seven single family P & I due at homes in Lancaster, CA Prime + 1% July 1, 1996 maturity Losses from unconsolidated investees F-44 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Schedule IV Mortgage Loans on Real Estate (Continued) December 31, 1996 Principal Amount of Loan Subject to Delinquent Face Amount Carrying Amount Principal or Description Prior Liens of Mortgages of Mortgages (F1) Interest - -------------------------------------------------------------------------------- - ---------- Note secured by: Timeshare Interests Oxnard, CA None $ 84,000 $ 19,000 None 50 percent interest in unsecured note related 1st T.D. to 177 lots in of 2,115,000 Lancaster, CA $3,266,000 (50% - 1,059,000) 1,059,000 $ 1,059,000 50 percent interest in First Trust Deed on 166 lots in 3,266,000 Lancaster, CA None (50% - 1,636,000) 771,000 771,000 F-45 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Schedule IV Mortgage Loans on Real Estate (Continued) December 31, 1996 Principal Amount of Loan Subject to Delinquent Face Amount Carrying Amount Principal or Description Prior Liens of Mortgages of Mortgages (F1) Interest - -------------------------------------------------------------------------------- - ---------- Note secured by: 50 percent interest in 1st T.D. on four 1st T.D. single family homes of 490,000 in Lancaster, CA $3,266,000 (50% - 245,000) 245,000 245,000 50 percent interest in 1st T.D. on seven single family homes in 804,000 Lancaster, CA None (50% - 402,000) 285,000 285,000 - -------------------------------------------------------------------------------- - ---------- Losses from unconsolidated investees (1,311,000) (1,311,000) - -------------------------------------------------------------------------------- - ---------- $ 3,426,000 $ 1,068,000 $ 1,049,000 ================================================================================ ========== Aggregate cost for Federal Income Tax purposes is $3,094,000 at December 31, 1996. The Partnership is in the process of extending this note. F-46 CENTENNIAL MORTGAGE INCOME FUND II AND SUBSIDIARIES A Limited Partnership Schedule IV Mortgage Loans on Real Estate (Continued) December 31, 1996 The following is a summary of activity for the years ended December 1996, 1995 and 1994. 1996 1995 1994 - -------------------------------------------------------------------------------- - ---------- Balance at beginning of year $ 1,856,000 $ 3,118,000 $ 883,000 Additions during period: New mortgage loans/disbursements 336,000 821,000 217,000 Other - Interest reserve and amortization 83,000 --- 8,000 Loans transferred from real estate owned --- --- 3,003,000 Loans transferred from restricted cash --- --- 501,000 Deductions during period: Collections of principal (148,000) (280,000) (1,016,000) Charge-offs --- --- (73,000) Losses from unconsolidated investees (1,059,000) (1,803,000) (405,000) - -------------------------------------------------------------------------------- - ---------- Balance at year end $ 1,068,000 $ 1,856,000 $ 3,118,000 ================================================================================ ==========
See accompanying independent auditors' report. F-47 Exhibit 21 LCR DEVELOPMENT, INC. A California Corporation Index to Consolidated Financial Statements Consolidated Financial Statements Page Independent Auditors' Report ........................... F-49 Consolidated Balance Sheets -- December 31, 1996 and 1995.............................. F-50 Consolidated Statements of Operations -- Years ended December 31, 1996, 1995 and 1994............ F-52 Consolidated Statements of Stockholders' Equity (Deficit) Years ended December 31, 1996, 1995 and 1994............ F-53 Consolidated Statements of Cash Flows -- Years ended December 31, 1996, 1995 and 1994............ F-54 Notes to Consolidated Financial Statements ............. F-57 F-48 INDEPENDENT AUDITORS' REPORT The Board of Directors LCR Development, Inc.: We have audited the consolidated balance sheets of LCR Development, Inc. and subsidiary (the "Company") as of December 31, 1996 and 1995 and the related statements of operations, stockholders' equity (deficit) and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LCR Development, Inc. and subsidiary as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations and has various notes payable scheduled to mature in 1997. These items raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. KPMG Peat Marwick LLP Orange County, California April 18, 1997, except as to the first paragraph of Note 6, which is as of July 29, 1997 F-49 LCR Development, Inc. Consolidated Balance Sheets
December 31, December 31, Assets 1996 1995 - ----------------------------------------------------------------- Restricted cash $ 10,000 $ --- Real estate owned (note 5) 6,492,000 5,263,000 Less allowance for losses on real estate investments (note 4) 3,898,000 1,390,000 - ----------------------------------------------------------------- Net real estate owned 2,594,000 3,873,000 Organization costs 1,000 2,000 - ----------------------------------------------------------------- $ 2,605,000 $ 3,875,000 ================================================================= Liabilities and Stockholders' Equity (Deficit) - ----------------------------------------------------------------- Notes payable to affiliates: CMIF $ 4,092,000 $ 2,973,000 CMIF II 2,360,000 2,092,000 - ----------------------------------------------------------------- Total notes payable (note 7) 6,452,000 5,065,000 Accounts payable and accrued liabilities 11,000 1,000 Interest payable to affiliates 845,000 509,000 Payable to affiliates (note 6) 16,000 1,000 - ----------------------------------------------------------------- Total liabilities 7,324,000 5,576,000 F-50 LCR Development, Inc. Consolidated Balance Sheets (Continued)
Liabilities and December 31, December 31, Stockholders' Equity (Deficit) 1996 1995 - ----------------------------------------------------------------- Stockholders' equity (deficit) Common stock, no par value; 300 shares authorized; 300 shares issued and outstanding in 1996 and 1995 3,000 3,000 Accumulated deficit (4,722,000) (1,704,000) - ----------------------------------------------------------------- Total stockholders' equity (deficit) (4,719,000) (1,701,000) Commitments (note 9) - ----------------------------------------------------------------- $ 2,605,000 $ 3,875,000 =================================================================
See accompanying notes to consolidated financial statements F-51 LCR Development, Inc. Consolidated Statements of Operations
Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Housing sales $ 233,000 $ --- $ --- Cost of housing sales 238,000 --- --- Provision for losses on real estate owned (note 4) 2,516,000 1,077,000 313,000 Selling and marketing expenses 184,000 --- --- General and administrative 162,000 (3,000) 3,000 - ----------------------------------------------------------------- Operating loss (2,867,000) (1,074,000) (316,000) Interest expense (note 5) 151,000 --- 313,000 - ----------------------------------------------------------------- Loss before income taxes $(3,018,000) $(1,074,000) $ (629,000) - ----------------------------------------------------------------- Income taxes (note 8) --- --- --- - ----------------------------------------------------------------- Net loss $(3,018,000) $(1,074,000) $ (629,000) ================================================================= Net loss per common share $ (10,060) $ (3,580) $ (2,097) ================================================================= Weighted average number of common shares outstanding 300 300 300 =================================================================
See accompanying notes to consolidated financial statements F-52 LCR Development, Inc. Consolidated Statements of Stockholders' Equity (Deficit)
Years ended December 31, 1996, 1995 and 1994 Total Stockholders' Common Accumulated Equity Stock Deficit (Deficit) - ----------------------------------------------------------------- Balance (deficit) at December 31, 1993 $ 3,000 $ (1,000) $ 2,000 Net loss --- (629,000) (629,000) - ----------------------------------------------------------------- Balance (deficit) at December 31, 1994 3,000 (630,000) (627,000) Net loss --- (1,074,000) (1,074,000) - ----------------------------------------------------------------- Balance (deficit) at December 31, 1995 3,000 (1,704,000) (1,701,000) Net loss --- (3,018,000) (3,018,000) - ----------------------------------------------------------------- Balance (deficit) at December 31, 1996 $ 3,000 $ (4,722,000) $ (4,719,000) =================================================================
See accompanying notes to consolidated financial statements F-53 LCR Development, Inc. Consolidated Statements of Cash Flows
Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Cash flows from operating activities: Net loss $(3,018,000) $(1,074,000) $ (629,000) Adjustments to reconcile net loss to cash provided by (used in) operating activities: Provision for possible losses 2,516,000 1,077,000 313,000 Changes in assets and liabilities: (Increase) decrease in organization costs 1,000 --- (2,000) Increase in interest payable 151,000 --- 312,000 Increase in accounts payable and accrued liabilities 10,000 1,000 --- Increase in payable to affiliates 15,000 1,000 --- - ----------------------------------------------------------------- Net cash provided by (used in) operating activities (325,000) 5,000 (6,000) - ----------------------------------------------------------------- Cash flows from investing activities: Capital expenditures for real estate owned (1,104,000) (1,207,000) (401,000) Proceeds from sale of real estate owned 233,000 --- --- Increase in restricted cash (10,000) --- --- - ----------------------------------------------------------------- F-54 LCR Development, Inc. Consolidated Statements of Cash Flows (Continued) Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Net cash used in investing activities (881,000) (1,207,000) (401,000) - ----------------------------------------------------------------- Cash flows from financing activities- Advances received on notes payable 1,206,000 1,200,000 407,000 - ----------------------------------------------------------------- Net decrease in cash --- (2,000) --- Cash at beginning of year --- 2,000 2,000 - ----------------------------------------------------------------- Cash at end of year $ --- $ --- $ 2,000 ================================================================= F-55 LCR Development, Inc. Consolidated Statements of Cash Flows (Continued) Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 - ----------------------------------------------------------------- Supplemental schedule of noncash investing and financing activities: Increase in real estate owned and related notes payable to affiliates as a result of transfer of ownership $ --- $ --- $ 3,365,000 Increase in real estate owned as a result of capitalized interest 366,000 290,000 --- Decrease in real estate owned and related allowance for losses due to sale of real estate owned 8,000 --- --- Increase in notes payable to affiliates as a result of capitalized interest 181,000 93,000 --- Increase in interest payable to affiliates as a result of capitalized interest 185,000 197,000 ---
See accompanying notes to consolidated financial statements F-56 LCR DEVELOPMENT, INC. Notes to Consolidated Financial Statements December 31, 1996, 1995, 1994 (1) Summary of Significant Accounting Policies Organization During 1993, LCR Development, Inc. ("LCR") was formed by Centennial Mortgage Income Fund ("CMIF") and Centennial Mortgage Income Fund II ("CMIF II") to own and operate one of their real estate assets, 179 single family lots in Lancaster, California. During 1994, Silverwood Homes, a California general partnership ("Silverwood"), was formed between LCR and Home Devco, Inc. ("Home Devco") for the purpose of constructing single family homes at the real estate project located in Lancaster. LCR contributed the 179 single family lots to the partnership in exchange for a capital contribution credit of $2,571,594 and Home Devco contributed $100 in cash. As LCR has contributed a 99.9 percent interest, Silverwood has been consolidated in the accompanying consolidated financial statements. All significant intercompany balances and transactions including the aforementioned contribution, have been eliminated in consolidation. LCR is entitled to a cumulative priority interest in cash available for distribution from the sale of homes equal to $19,381 per lot. Home Devco is acting as the general contractor in the construction of homes at the project and is entitled to fifty percent of any cash available for distribution from the sale of homes after LCR has received distributions equal to its priority interest. Home Devco is also entitled to reimbursement of onsite supervision costs and certain general and administrative costs. Real Estate Owned During 1995 and 1994, LCR accounted for foreclosed assets using the American Institute of Certified Public Accountants Statement of Position 92-3 ("SOP 92-3"), "Accounting for Foreclosed Assets". SOP 92-3 indicated that foreclosed assets were presumed held for sale and not for the production of income. Accordingly, foreclosed assets held for sale were carried at the lower of cost or fair value less estimated costs to sell. The cost of such assets at the time of foreclosure was the fair value of the asset foreclosed. Immediately after foreclosure, a valuation allowance was recognized for estimated costs to sell through a charge to operations. F-57 Effective January 1, 1996, LCR adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"). SFAS 121 supersedes SOP 92-3 and also requires that long-lived assets to be disposed of be reported at the lower of carrying amount or fair value less costs to sell. An impairment loss shall be measured as the amount by which the carrying amount of the assets exceed the fair value of the assets less costs to sell. Revenue Recognition LCR recognizes revenue from sales of real estate when construction is completed, an adequate down payment has been received and title to the property sold has been transferred to the buyer. Income Taxes LCR is subject to taxation and accounts for income taxes under Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 requires an asset and liability approach to establishing deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the corporation's assets and liabilities. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenue and expenses during the reporting period. Actual results could differ from those estimates. (2) Ability to Continue as a Going Concern LCR and Silverwood were formed to own and develop the 179 lots in Lancaster, California. During 1994 and 1995, operations did not generate sufficient cash to cover current obligations as the project was still being developed. During 1996, operations did not generate sufficient cash to cover current obligations due to the lack of sales of homes. Sales volumes of new homes in the Lancaster area have continued to decline since 1995 while sales F-58 prices have remained relatively flat and construction costs have increased. The note payable originally secured by the nine lots in Lancaster (Phase I) which matured July 1, 1996 has been extended to allow sufficient time for the sale of the balance of the homes. Based on representations by the general partners of CMIF and CMIF II, the $2,115,000, the $1,250,000 and the $1,748,000 notes payable to CMIF and CMIF II which all mature during 1997 will be extended indefinitely while the project is being developed. However, if LCR's and Silverwood's financial condition worsens significantly, these intentions could change. Phase II at the project is currently under development. Prior to commencing additional phases, management will reevaluate its investment alternatives including, but not limited to, the cessation of construction and holding of the lots for investment or the bulk sale of the remaining lots. Management is continuously monitoring all aspects of the project and its impact on LCR, CMIF and CMIF II. (3) Fair Value of Financial Instruments Statement of Financial Accounting Standard No. 107 "Disclosures About Fair Value of Financial Instruments" ("SFAS 107"), requires that LCR discloses estimated fair values for its financial instruments as well as the methods and significant assumptions used to estimate fair values. The following information does not purport to represent the aggregate net fair value of LCR. The following methods and assumptions were used by LCR in estimating the fair value of each class of financial instrument. Restricted Cash The carrying amount, which is cost, is assumed to be the fair value. Notes Payable to Affiliates and Interest Payable to Affiliates The fair value is not determinable due to their related party nature and terms. Accounts Payable and Accrued Liabilities and Payable to Affiliates The carrying value is considered to be equal to the fair value of these liabilities as they are short-term in nature. F-59 (4) Allowance for Possible Losses on Real Estate Owned Changes in the allowance for possible losses on real estate owned are as follows: 1996 1995 1994 - ----------------------------------------------------------------- Balance at beginning of year $1,390,000 $ 313,000 $ --- Real estate owned charged-off (8,000) --- --- Provision for losses 2,516,000 1,077,000 313,000 - ----------------------------------------------------------------- Balance at end of year $3,898,000 $1,390,000 $ 313,000 =================================================================
(5) Real Estate Owned Real estate owned balances at December 31, 1996, 1995 and 1994 were $6,492,000, $5,263,000 and $3,766,000, respectively. The property was transferred to LCR in 1994 at CMIF and CMIF II's cost, with a balance of $3,365,000. Capitalized interest for the years ended December 31, 1996 and 1995 totaled $366,000 and $290,000, respectively. There was no capitalized interest for 1994. No interest was paid for the years ended December 31, 1996, 1995 and 1994. Sales of real estate owned were $233,000 for the year ended December 31, 1996. There were no sales of homes for the years ended December 31, 1995 and 1994. Charge- offs recorded in 1996 were $8,000. There were no charge-offs recorded for the years ended December 31, 1995 and 1994. Total interest incurred for the years ended December 31, 1996, 1995 and 1994 was $517,000, $290,000 and $313,000, respectively. In accordance with SFAS 121, LCR carries real estate owned, held for sale, at the lower of carrying amount, or fair value less costs to sell. The estimated fair value was determined by using appraisals, discounted cash flows and/or other valuation techniques. The actual market price of real estate can only be determined by negotiation between independent third parties in a sales transaction and sales proceeds could differ substantially from estimated fair values. F-60 (6) Transactions with Affiliates The general partners of CMIF and CMIF II beneficially own a controlling interest in Home Devco. Under the provisions of the Partnership Agreement, Home Devco is entitled to receive from LCR reimbursement of onsite supervision costs and certain general and administrative costs equal to 3 percent of budgeted gross proceeds or a maximum of $20,000 per month. Home Devco is entitled to receive a minimum fee of $7,500 per month under the agreement, as amended. LCR paid $160,000, $143,000 and $5,000 of these costs to Home Devco and affiliates for the years ended December 31, 1996, 1995 and 1994, respectively. Through December 31, 1996, fees paid have exceeded amounts payable under the agreement by $50,000, however, management believes that these fees are appropriate based on the completed project and has temporarily reduced the amount being paid to Home Devco to $5,000 per month effective January 1, 1997. Funds have been advanced from CMIF II to meet operating expenses and fund options on the prospective home sales. Once the sales have been completed, the advances are to be repaid from sales proceeds. The balances at December 31, 1996 and 1995 were $16,000 and $1,000, respectively. (7) Notes Payable to Affiliates
Notes payable to affiliates consist of the following: (dollars in thousands) December 31, December 31, 1996 1995 - ----------------------------------------------------------------- Unsecured note payable to CMIF and CMIF II related to 179 lots in Lancaster, CA with principal and interest payable at maturity interest rate of 7.75% fixed, maturing December 1, 1997 $ 2,115 $ 2,115 F-61 Notes payable to affiliates consist of the following: (continued) (dollars in thousands) December 31, December 31, 1996 1995 - ----------------------------------------------------------------- Unsecured note payable to CMIF related to 179 lots in Lancaster, CA with principal and interest payable at maturity; interest rate of 7.75% fixed maturing December 1, 1997 1,250 1,250 Note payable to CMIF and CMIF II secured by first trust deed on 166 lots in Lancaster, CA with principal and interest due at maturity; interest at Prime + 1%; maturing August 1, 1997 1,748 896 Note payable to CMIF and CMIF II secured by first trust deed on 4 lots in Lancaster, CA with principal and interest due at maturity; interest at Prime +1%; maturing July 1, 1998 484 416 Note payable to CMIF and CMIF II originally secured by first trust deed on 9 lots in Lancaster, CA with principal and interest due at maturity; interest at Prime + 1%; matured July 1, 1996 855 388 - ----------------------------------------------------------------- Total notes payable $ 6,452 $ 5,065 =================================================================
F-62 Future principal payments to be paid as of December 31, 1996 are as follows:
(dollars in thousands) Years ending December 31, - ----------------------------------------------------------------- 1996 $ 855 1997 5,113 1998 484 - ----------------------------------------------------------------- $6,452 =================================================================
The note payable originally secured by a first trust deed on 9 lots in Lancaster which matured July 1, 1996 has been extended indefinitely (see note 2). (8) Income Taxes LCR and Silverwood file separate Federal and State income tax returns. LCR and Silverwood have been consolidated for the following schedules. A reconciliation of income tax expense (benefit) at the Federal statutory rate of 34% to LCR's and Silverwood's provision for taxes is as follows:
1996 1995 1994 - ----------------------------------------------------------------- Income tax benefit at the statutory rate $(1,026,000) $ (365,000) $ (214,000) State tax benefit, net of Federal tax benefit (184,000) (66,000) (38,000) Valuation allowance 1,204,000 430,000 252,000 Other 6,000 1,000 --- - ----------------------------------------------------------------- Total --- --- --- =================================================================
F-63 As of December 31, 1996, LCR and Silverwood have net operating loss carryforwards of approximately $211,000, expiring at various dates through 2011. The components of the consolidated net deferred tax asset at December 31, 1996, 1995 and 1994 are as follows:
1996 1995 1994 - ----------------------------------------------------------------- Net operating loss carryforwards $ 78,000 $ --- $ 2,000 Provision for losses on real estate 1,563,000 557,000 125,000 Capitalized interest (1,000) 46,000 125,000 Interest not deductible until paid 185,000 79,000 --- Section 263A expenses 61,000 --- --- - ----------------------------------------------------------------- 1,886,000 682,000 252,000 - ----------------------------------------------------------------- Less valuation allowance (1,886,000) (682,000) (252,000) - ----------------------------------------------------------------- $ --- $ --- $ --- =================================================================
The net increases in the total valuation allowances for the years ended December 31, 1996 and 1995 was an increase of $1,204,000 and $430,000, respectively. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based upon the losses of LCR and Silverwood, management has determined that part or all of the consolidated deferred tax assets may not be realized in the future. Accordingly, management has provided a valuation allowance against the value of the deferred tax asset. F-64 (9) Commitments During the first quarter of 1997, Silverwood signed a contract with a subcontractor for $231,000. F-65 -----END PRIVACY-ENHANCED MESSAGE-----