Greystone Housing Impact Investors LP - Annual Report: 2007 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Commission file number: 000-24843

 

AMERICA FIRST TAX EXEMPT INVESTORS, L.P.

(Exact name of registrant as specified in its Agreement of Limited Partnership)

 

 

(402) 444-1630

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Beneficial Unit Certificates representing assignments of limited partnership interests in

America First Tax Exempt Investors, L.P. (the “BUCs”)

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports, and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of the chapter) is not contained herein, and will not be contained, to the best of the 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.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.  o

 

The aggregate market value of the registrant’s BUCs held by non-affiliates based on the final sales price of the BUCs on the last business day of the registrant’s most recently completed second fiscal quarter was $108,373,683.

 

DOCUMENTS INCORPORATED BY REFERENCE
None

 

 

TABLE OF CONTENTS

 

 

Forward-Looking Statements

 

This report (including, but not limited to, the information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”) contains forward-looking statements that reflect management’s current beliefs and estimates of future economic circumstances, industry conditions, America First Tax Exempt Investors, L.P.’s (the “Partnership”) performance and financial results. All statements, trend analysis and other information concerning possible or assumed future results of operations of the Partnership and the investments it has made constitute forward-looking statements. Beneficial Unit Certificate (“BUC”) holders and others should understand that these forward-looking statements are subject to numerous risks and uncertainties, and a number of factors could affect the future results of the Partnership and could cause those results to differ materially from those expressed in the forward-looking statements contained herein. These factors include general economic and business conditions such as the availability and credit worthiness of prospective tenants, lease rents, operating expenses, the terms and availability of financing for properties financed by the tax-exempt mortgage revenue bonds owned by the Partnership, adverse changes in the real estate markets from governmental or legislative forces, lack of availability and credit worthiness of counter parties to finance future acquisitions and interest rate fluctuations and other items discussed under “Risk Factors” in Item 1A of this report.

 

 

The Partnership was formed on April 2, 1998 under the Delaware Revised Uniform Limited Partnership Act for the purpose of acquiring, holding, selling and otherwise dealing with a portfolio of federally tax-exempt mortgage revenue bonds which have been issued to provide construction and/or permanent financing of multifamily residential properties. Interest on these bonds is excludable from gross income for federal income tax purposes. As a result, most of the income earned by the Partnership is exempt from federal income taxes. Our general partner is America First Capital Associates Limited Partnership Two (“AFCA 2”), whose general partner is The Burlington Capital Group LLC (“Burlington”). Since 1984, Burlington has specialized in the management of investment funds, many of which were formed to acquire real estate investments such as tax-exempt mortgage revenue bonds, mortgage securities and multifamily real estate properties.

 

As of December 31, 2007, the Partnership owned 20 tax-exempt mortgage revenue bonds which were issued to finance 16 apartment properties located in the states of Florida, Indiana, Iowa, South Carolina, Texas, Nebraska, Kansas and Kentucky containing a total of 2,448 rental units and 460 rental units under construction and a 142-bed student housing facility in Nebraska. Each of these mortgage revenue bonds provides for the payment of fixed-rate base interest to the Company. Additionally, 10 of the 20 bonds also provide for the payment of contingent interest based upon net cash flow and net capital appreciation of the underlying real estate properties. As a result, these mortgage revenue bonds provide the Company with the potential to participate in future increases in the cash flow generated by the financed properties, either through operations or from their ultimate sale. Ten of the 17 properties which collateralize the bonds owned by the Partnership are managed by America First Properties Management Company L.L.C., an affiliate of the Partnership. Management believes that this relationship provides greater insight and understanding of the underlying property operations and the property’s ability to meet debt service requirements to the Partnership.

 

The amount of interest income earned by the Partnership from its investment in tax-exempt mortgage revenue bonds is a function of the net operating income generated by the properties collateralizing the tax-exempt mortgage revenue bonds. Net operating income from a multifamily residential property depends on the rental and occupancy rates of the property and the level of operating expenses. Occupancy rates and rents are directly affected by the supply of, and demand for, apartments in the market areas in which a property is located. This, in turn, is affected by several factors such as local or national economic conditions, the amount of new apartment construction and interest rates on single-family mortgage loans. In addition, factors such as government regulation, inflation, real estate and other taxes, labor problems and natural disasters can affect the economic operations of a property. Therefore, the return to the Partnership depends upon the economic performance of the multifamily residential properties which collateralize the tax-exempt mortgage revenue bonds. For this reason, the Partnership’s investments are dependent

on the economic performance of such real estate and may be considered to be in competition with other income-producing real estate of the same type in the same geographic areas.

 

The Partnership may invest in other types of tax-exempt securities that may or may not be secured by real estate. These tax-exempt securities must be rated in one of the four highest rating categories by at least one nationally recognized securities rating agency and may not represent more than 25% of our assets at the time of acquisition. The Partnership may also make taxable mortgage loans secured by multifamily properties which were financed by tax-exempt mortgage revenue bonds that the Partnership holds. The Partnership generally does not seek to acquire direct interests in real property as long term or permanent investments. The Partnership may, however, acquire direct interests in real property in order to position itself for a future investment in tax-exempt bonds. Additionally, it may acquire apartment complexes securing its revenue bonds or taxable mortgage loans through foreclosure in the event of a default.

 

As of December 31, 2007, the Partnership had a direct ownership interest in six Ohio limited partnerships that own four apartment properties located in Ohio and two apartment properties located in Kentucky containing a total of 544 rental units. The Partnership expects to ultimately restructure these properties by providing tax-exempt bond financing to new owners through a sale of the individual properties. All six of these properties are managed by America First Properties Management Company L.L.C., an affiliate of the Partnership. Management believes that this relationship provides greater insight and understanding of the underlying property operations and the property’s ability to meet debt service requirements to the Partnership.

 

Business Objectives and Strategy

 

Overview

 

The Partnership was formed for the primary purpose of acquiring, holding, selling and otherwise dealing with a portfolio of federally tax-exempt mortgage revenue bonds which have been issued to provide construction and/or permanent financing of multifamily residential apartments. The Partnership’s business objectives are to: (i) preserve and protect its capital; (ii) provide regular cash distributions to BUC holders; and (iii) provide a potential for an enhanced federally tax-exempt yield as a result of a participation interest in the net cash flow and net capital appreciation of the underlying real estate properties financed by the tax-exempt mortgage revenue bonds.

 

We are pursuing a business strategy of acquiring additional tax-exempt mortgage revenue bonds on a leveraged basis in order to (i) increase the amount of tax-exempt interest available for distribution to our BUC holders; (ii) reduce risk through asset diversification and interest rate hedging; and (iii) achieve economies of scale. We are pursuing this growth strategy by investing in additional tax-exempt mortgage revenue bonds and related investments, taking advantage of attractive financing structures available in the tax-exempt securities market and entering into interest rate risk management instruments. We may finance the acquisition of additional tax-exempt mortgage revenue bonds through the reinvestment of cash flow, the issuance of additional BUCs, or securitization financing using our existing portfolio of tax-exempt mortgage revenue bonds. Our operating policy is to use securitizations or other forms of leverage to maintain a level of debt financing between 40% and 60% of the total fair value of our assets.

 

In connection with our growth strategy, we are also assessing opportunities to reposition our existing portfolio of tax-exempt mortgage revenue bonds. The principal objective of this repositioning initiative is to improve the quality and performance of our revenue bond portfolio and, ultimately, increase the amount of cash available for distribution to our BUC holders. In some cases, we may elect to redeem selected tax-exempt bonds that are secured by multifamily properties that have experienced significant appreciation. Through the selective redemption of the bonds, a sale or refinancing of the underlying property will be required which, if sufficient sale or refinancing proceeds exist, will entitle the Company to receive payment of accrued contingent interest on its bond investment. In other cases, we may elect to sell bonds on properties that are in stagnant or declining markets. The proceeds received from these transactions would be redeployed into other tax-exempt investments consistent with our investment objectives. We may also be able to use a higher-quality investment portfolio to obtain higher leverage to be used to acquire additional investments.

Another goal of our repositioning strategy is to allow for the preparation of financial statements that more accurately reflect the nature of the Company as a tax-exempt bond fund rather than as an owner of apartment properties. As of December 31, 2007, generally accepted accounting principles, in particular Financial Accounting Standards Board (“FASB”) Interpretation No. 46R (“FIN 46R”), require us to present the financial results of eight of the properties financed with tax-exempt bonds owned by us on a consolidated basis with our financial results. The consolidation of underlying apartment properties under FIN 46R results mainly from the participation interest in the net cash flow and net capital appreciation from the payment of both base interest and contingent interest under the mortgage revenue bonds issued to finance the consolidated properties. By repositioning the investment portfolio into tax-exempt mortgage bonds which do not result in consolidation of the underlying property, we will be able to present our financial results in what we believe is a more understandable and transparent manner.

 

In executing our growth strategy, we expect to invest primarily in bonds issued to provide affordable rental housing, but may also consider bonds issued to finance student housing projects and housing for senior citizens. The four basic types of multifamily housing revenue bonds which we may acquire as investments are as follows:

 

1. Private activity bonds issued under Section 142(d) of the Internal Revenue Code of 1986, as amended (the “Code”);

 

2. Bonds issued under Section 145 of the Code by not-for-profit entities qualified under Section 501(c) 3 of the Code;

 

3. Essential function bonds issued by a public instrumentality to finance an apartment property owned by such instrumentality; and

 

4. Existing “80/20 bonds” that were issued under section 103(b)(4)(A) of the Internal Revenue Code of 1954.

 

Each of these bond structures permits the issuance of tax-exempt bonds to finance the construction or acquisition and rehabilitation of affordable rental housing. Under applicable Treasury Regulations, any affordable apartment project financed with tax-exempt bonds must set aside a percentage of its total rental units for occupancy by tenants whose incomes do not exceed stated percentages of the median income in the local area. In each case, the balance of the rental units in the apartment project may be rented at market rates. With respect to private activity bonds issued under Section 142(d) of the Code, the owner of the apartment project may elect, at the time the bonds are issued, whether to set aside a minimum of 20% of the units for tenants making less than 50% of area median income (as adjusted for household size) or 40% of the units for tenants making less than 60% of the area median income (as adjusted for household size). Multifamily housing bonds that were issued prior to the Tax Reform Act of 1986 (so called “80/20” bonds) require that 20% of the rental units be set aside for tenants whose income does not exceed 80% of the area median income, without adjustment for household size.

 

We expect that many of the private activity housing bonds that we evaluate for acquisition will be issued in conjunction with the syndication of Low Income Housing Tax Credits under Section 42 of the Code (“LIHTCs”) by the owner of the financed apartment project. Additionally, to facilitate its investment strategy of acquiring additional tax-exempt mortgage bonds secured by multifamily apartment properties (“MF Properties”), the Partnership may acquire ownership positions in the MF Properties. The Partnership expects to ultimately restructure the property ownership through a sale of the MF Properties and a syndication of LIHTCs.

 

Investment Types

 

Tax-Exempt Mortgage Revenue Bonds.  The Company invests in tax-exempt mortgage revenue bonds. The amount of interest income earned by the Company from its investment in tax-exempt mortgage revenue bonds is a function of the net operating income generated by the properties collateralizing the tax-exempt mortgage revenue bonds. Net operating income from a multifamily residential property depends on the rental and occupancy rates of the property and the level of operating expenses.

 

Other Tax-Exempt Securities.  The Company may invest in other types of tax-exempt securities that may or may not be secured by real estate. These tax-exempt securities must be rated in one of the four highest rating categories by at least one nationally recognized securities rating agency and may not represent more than 25% of our assets at the time of acquisition.

Taxable Mortgage Loans.  The Company may also make taxable mortgage loans secured by multifamily properties which were financed by tax-exempt mortgage revenue bonds that we hold.

 

Real Estate.  While the Company generally does not seek to acquire equity interests in real property as long term or permanent investments it may acquire apartment complexes securing its revenue bonds or taxable mortgage loans through foreclosure in the event of a default. In addition, as part of its growth strategy, the Company may acquire direct or indirect interests in apartment complexes in order to position itself for a future investment in tax-exempt mortgage revenue bonds issued to finance the acquisition or substantial rehabilitation of such apartment complexes by a new owner. A new owner would typically seek to obtain LIHTCs in connection with the issuance of the new tax-exempt bonds, but if LIHTCs had previously been issued for the property, such a restructuring could not occur until the expiration of a 15-year compliance period for the initial LIHTCs. The Company may acquire an interest in such MF Properties prior to the end of the LIHTC compliance period. After the LIHTC compliance period, the Company would expect to sell such MF properties to a new owner which could syndicate new LIHTCs and seek tax-exempt bond financing on the property which the Company could acquire. Such restructurings will generally be expected to occur within 36 months of the acquisition by the Company of an interest in a MF Property. The Company will not acquire LIHTCs in connection with these transactions.

 

Effect of Adoption of FIN 46R on Financial Reporting

 

The Partnership is required to consolidate the assets, liabilities, results of operations and cash flows of certain entities that meet the definition of a “variable interest entity” (“VIE”) into the Partnership’s financial statements under the provisions of FIN 46R. Management has determined that eight of the entities which own multifamily apartment properties financed by the Partnership’s tax-exempt mortgage revenue bonds are VIEs. Because management determined that the Partnership is the primary beneficiary of each of these VIEs pursuant to the terms of each tax-exempt mortgage revenue bond and the criteria within FIN 46R, the Partnership consolidated the assets, liabilities and results of operations of these VIEs’ multifamily properties into the Partnership’s financial statements. Transactions and accounts between the Partnership and the consolidated VIEs, including the indebtedness underlying the tax-exempt mortgage bonds secured by the properties owned by the VIEs, have been eliminated in consolidation.

 

All financial information in this Form 10-K presented on the basis of Accounting Principles Generally Accepted in the United States of America (GAAP), is that of the Partnership and the VIEs on a consolidated basis. We refer to the Partnership, its wholly owned subsidiary America First LP Holding Corp (“Holding Corp”), and the consolidated VIEs throughout this Form 10-K as the “Company”. We refer to the Partnership and Holding Corp, without consolidation of the VIEs, as the “Partnership.”

 

Financing Strategy

 

We have financed acquisitions of additional revenue bonds through a securitization transaction offered through the Merrill Lynch proprietary residual interest tax-exempt securities and puttable floating option tax-exempt receipts “P-Float” program. In a securitization transaction, we deposit a tax-exempt mortgage revenue bond into a trust which issues two types of securities, senior securities (“P-Floats”) and subordinated residual interest securities (“RITES”). The P-Floats are floating-rate securities representing a beneficial ownership interest in the outstanding principal and interest of the tax-exempt mortgage revenue bond credit-enhanced by Merrill Lynch (or a Merrill Lynch affiliate) and sold to institutional investors. The interest rate paid on the P-Floats reflects a spread over the Securities Industry and Financial Market Association (“SIFMA”, formerly the “BMA”) floating rate index. We receive the net proceeds from the sale of the P-Floats and may use these funds to make additional investments. The RITES are issued to us and represent a beneficial ownership interest in the remaining interest on the underlying tax-exempt mortgage revenue bond. We maintain a call option on the senior P-Float securities and this allows us to collapse the trusts and retain a level of control over the underlying revenue bond. The call price of a P-Float is equal to its par amount plus 10% of any increase in the market value of the underlying revenue bonds. We account for these transactions as secured borrowings, and they, in effect, provide us with variable-rate financing. Accordingly, we record these senior certificates as debt financing, the revenue bonds as investment securities held in trust, and the RITES as other assets. There are certain risks associated with the use of P-Floats which are discussed in more detail

in Item 1A “Risk Factors” and Item 7A “Quantitative and Qualitative Disclosures about Market Risks” and elsewhere in this Annual Report on Form 10-K.

 

In addition to the P-Float program the Partnership may utilize other forms of borrowing. Such borrowings may include mortgage loans secured by owned real estate and revolving lines of credit.

 

Recent Developments

 

Effects of Recent Changes in Credit Markets.

 

The credit issues experienced recently by the single-family subprime mortgage industry have affected interest rates and availability of credit generally. Although the consequences of these events and their impact on our ability to pursue our plan to grow through investments in additional tax-exempt bonds secured by first mortgages on affordable multifamily housing projects are not fully known, we do not anticipate that our existing assets will be adversely affected by these events. The Company does not issue mortgage loans secured by mortgages on single-family residential properties or acquire securities backed by single-family mortgage loans.

 

We believe that if there are continued defaults on subprime single family mortgages and a general contraction of credit available for single family mortgage loans, additional demand for affordable rental housing may be created and, as a result, may have a positive economic effect on apartment properties financed by the tax-exempt bonds held by the Partnership. We believe the current tightening of credit may also create opportunities for additional investments consistent with the Partnership’s investment strategy because it may result in fewer parties competing to acquire tax-exempt bonds issued to finance affordable housing. There can be no assurance that we will be able to finance additional acquisitions of tax-exempt bonds through either additional equity or debt financing.

 

Developments Affecting P-Float Financing

 

Historically, our primary leverage vehicle has been the Merrill Lynch P-Float program. Recent credit losses and credit rating downgrades at Merrill Lynch have resulted in a significant increase in Merrill Lynch’s cost of borrowing under the P-Float program since December 31, 2007. This is reflected in an increased spread over the SIFMA rate payable on the P-Floats. The increased spread over SIFMA has resulted in a significantly higher interest rate on the Partnership’s P-Float financing. As discussed in Item 7A, Quantitative and Qualitative Disclosures about Market Risks, the Partnership’s effective interest rate on its P-Float borrowings has increased approximately 1.25% to 2.0% from November 30, 2007 to February 29, 2008. A 1.5% increase in the Partnership’s effective interest rate, on an annualized basis, would result in approximately $1.1 million of additional interest expense on the Partnership’s existing P-Float financing. This additional interest expense will lower the Partnership’s cash available for distribution (“CAD”).

 

In addition, if the interest rate on the P-Floats rises to a level where the interest received on the underlying tax-exempt bonds is not sufficient to pay all interest due on the P-Floats, the P-Float may be terminated and the underlying tax-exempt mortgage revenue bonds may be sold in order to satisfy the obligations on the P-Floats. Due to these developments with our P-Float debt, we do not expect to have access to additional debt financing through the Merrill Lynch P-Float program for the foreseeable future and this is expected to limit our ability to acquire additional tax-exempt mortgage revenue bonds on a leveraged basis.

 

While the Partnership currently intends to maintain annual distributions of $0.54 per BUC, a reduction in CAD could result in a reduction in the distributions paid by the Partnership on its BUCs in the future. We are currently evaluating alternative financing vehicles to replace our P-Float debt in order to reduce our interest expense and in order to have access to new leverage financing for additional tax-exempt mortgage bonds on reasonable terms. We have not entered into any agreements with respect to any such alternative debt financing and there can be no assurances that we will be able to do so.

 

Line of Credit

 

In January 2008, the Partnership entered into a $5.0 million line of credit. The line of credit is available for new investments and general working capital purposes. It is secured by certain mortgage revenue bonds and bears interest at a variable rate of prime minus 0.5% per annum.

Beneficial Unit Certificate activity

 

In December 2007, the Partnership announced that Burlington had adopted a prearranged trading plan (the “Plan”) with RBC Dain Rauscher (“RBC”) under which RBC will acquire BUCs in open market purchases made from time to time for the account of Burlington beginning January 1, 2008. Burlington may acquire up to $2.0 million of BUCs under the Plan. Burlington is the general partner of the Company’s general partner. As a result, the Plan was established in accordance with the guidelines specified by Rule 10b5-1 under the Securities Exchange Act of 1934.

 

In January 2007, the Company filed a Registration Statement on Form S-3 with the Securities and Exchange Commission (the “SEC”) relating to the sale of up to $100.0 million of its BUCs. The Company intends to issue BUCs from time to time under this Registration Statement to raise additional equity capital as needed to fund investment opportunities. Raising additional equity capital for deployment into new investment opportunities is part of our overall growth strategy outlined above Pursuant to this Registration Statement, in April 2007 the Company issued, through an underwritten public offering, a total of 3,675,000 BUCs at a public offering price of $8.06 per BUC. Net proceeds realized by the Company from the issuance of the additional BUCs were approximately $27.5 million, after payment of an underwriter’s discount and other offering costs of approximately $2.1 million. The proceeds were used to acquire additional tax-exempt revenue bonds and other investments meeting the Partnership’s investment criteria and for general working capital needs.

 

Investment activity

 

In February 2008, the Company acquired $4.5 million of tax-exempt housing bonds issued to finance the construction of the Woodlyn Village Apartments, a 59 unit apartment complex in Maplewood, Minnesota. The bonds represent 100% of the bond issuance, were purchased at par, and earn interest at a fixed annual rate of 6.0% with semi-annual interest payments. The stated maturity date of the bonds is November 1, 2042.

 

In January 2008, the Company acquired $7.9 million of tax-exempt housing bonds issued to finance the construction of the Bridle Ridge Apartments, a 152 unit apartment complex in Greer, South Carolina. The bonds represent 100% of the bond issuance, were purchased at par, and earn interest at a fixed annual rate of 6.0% with semi-annual interest payments. The stated maturity date of the bonds is January 1, 2043.

 

In October 2007, the Company acquired $10.8 million of tax-exempt housing bonds issued to finance Runnymede Apartments, a 252 unit apartment complex located in Austin, Texas. The bonds represent 100% of the bond issuance, were purchased at par, and earn interest at a fixed annual rate of 6.0% with semi-annual interest payments. The stated maturity date of the bonds is October 1, 2042.

 

In June 2007, the Company acquired $5.5 million Series A and $0.4 million Series B tax-exempt housing bonds issued to finance the construction of the Prairiebrook Village Apartments, a 72 unit apartment complex in Gardner, Kansas. The bonds represent 100% of the bond issuance, were purchased at par, and earn interest at an annual rate of 6.0% for the Series A and 8.0% for the Series B with semi-annual interest payments. The stated maturity date of the bonds is June 1, 2047. On February 11, 2008, the bond trustee notified the owner and developer of Prairiebrook Village that they were not in compliance with certain sections of the bond indenture. The occurrence and continuation of this non-compliance could become an event of default. The Partnership is currently working with the trustee, developer, and owners of the project to develop an action plan. Should the non-compliance become an event of default, the Partnership will evaluate all remedies at its disposal including foreclosure on the mortgage securing the bonds. If appropriate, the Partnership will seek to recover all funds still on deposit with the trustee, sell all assets owned by the project and pursue owner and developer guarantees. The Partnership anticipates that, should it have to exercise its remedies, amounts recovered will be sufficient to repay the par amount of the bonds.

 

In June 2007, America First LP Holding Corp. (“Holding Corp.”), a wholly-owned subsidiary of the Partnership, acquired the 99% limited partner interests in six Ohio limited partnerships (the “Property Partnerships”) for a cash purchase price of approximately $9.2 million plus assumed debt and other liabilities of approximately $15.7 million. Each Property Partnership owns a multifamily apartment property, of which four are located in Ohio and two are located in Kentucky. The cash portion of the purchase price was funded by cash on

hand. In connection with the acquisition, the Property Partnerships refinanced their existing debt with an aggregate loan of approximately $19.9 million. The interest rate on this mortgage is variable and is calculated as one month LIBOR plus 1.55%. As of the transaction date, LIBOR was 5.32% and the interest on the mortgage was 6.87%. As of December 31, 2007, one month LIBOR was 4.86% and the interest on the mortgage was 6.41%. The mortgage matures in July 2009. The Company has guaranteed the payment of certain exceptions from the nonrecourse provisions and certain environmental obligations, should they arise, in connection with the loan. The 1% general partner interests in the six Property Partnerships were acquired by Atlantic Development GP Holding Corp., a party unaffiliated with the Partnership, with the proceeds of an approximately $62,000 loan from Holding Corp. These 1% general partner interests are reflected in the Company’s consolidated financial statements as minority interests.

 

In May 2007, the Company acquired $15.1 million Series A and $0.6 million Series B tax-exempt housing bonds issued to finance the construction of the Woodland Park Apartments, a 236 unit apartment complex in Topeka, Kansas. The bonds represent 100% of the bond issuance, were purchased at par, and earn interest at an annual rate of 6.0% for the Series A and 8.0% for the Series B with semi-annual interest payments. The stated maturity date of the bonds is November 1, 2047. The apartment complex is currently under construction. Based on the construction schedule, finished units are expected to be available for leasing starting in May 2008 with a final completion of the project expected by May 2009.

 

In May 2007, the Company acquired $4.9 million of tax-exempt housing bonds issued to finance the construction of the Gardens of DeCordova Apartments, a 76 unit apartment complex in Granbury, Texas. The bonds represent 100% of the bond issuance, were purchased at par, and earn interest at an annual rate of 6.0% with semi-annual interest payments. The stated maturity date of the bonds is May 1, 2047. The apartment complex is currently under construction with an estimated completion date of November 2008 with some units available for rent prior to that date.

 

In May 2007, the Company acquired $4.7 million of tax-exempt housing bonds issued to finance the construction of the Gardens of Weatherford Apartments, a 76 unit apartment complex in Weatherford, Texas. The bonds represent 100% of the bond issuance, were purchased at par, and earn interest at an annual rate of 6.0% with semi-annual interest payments. The stated maturity date of the bonds is May 1, 2047. The apartment complex is currently under construction with an estimated completion date of November 2008.

 

The Company has determined that the underlying entities that own the Bridle Ridge Apartments, Runnymede Apartments, Prairiebrook Village Apartments, Woodland Park Apartments, the Gardens of DeCordova Apartments, and the Gardens of Weatherford Apartments which are financed by bonds owned by the Partnership do not meet the definition of a VIE and accordingly, their financial statements are not required to be consolidated into the Company’s consolidated financial statements under FIN 46R.

 

Management and Employees

 

The Partnership is managed by its general partner, America First Capital Associates Limited Partnership Two (“AFCA 2”). The Partnership has no employees, executive officers or directors. Certain services are provided to the Partnership by employees of Burlington, which is the general partner of AFCA 2, and the Partnership reimburses Burlington for its allocated share of these salaries and benefits. The Partnership is not charged, and does not reimburse Burlington, for the services performed by executive officers of Burlington.

 

Competition

 

The Partnership competes with private investors, lending institutions, trust funds, investment partnerships and other entities with objectives similar to the Partnership for the acquisition of tax-exempt mortgage revenue bonds and other investments. This competition could reduce the availability of tax-exempt mortgage revenue bonds for acquisition and reduce the interest rate that issuers pay on these bonds.

 

Because the Partnership holds tax-exempt mortgage revenue bonds secured entirely by multifamily residential properties and holds an interest in the MF Properties, the Partnership may be considered to be in competition with other residential real estate in the same geographic areas. In each city in which the properties collateralized by the Partnership’s tax-exempt mortgage revenue bonds owned by the Partnership or MF Properties are located, such

properties compete with a substantial number of other multifamily properties. Multifamily properties also compete with single-family housing that is either owned or leased by potential tenants. To compete effectively, the apartment properties financed or owned by the Partnership must offer quality apartments at competitive rental rates. In order to maintain occupancy rates and attract quality tenants, the Partnership’s apartment properties may also offer rental concessions, such as free rent to new tenants for a stated period. These apartment properties also compete by offering quality apartments in attractive locations and that provide tenants with amenities such as recreational facilities, garages and pleasant landscaping.

 

Environmental Matters

 

The Partnership believes that each of the MF Properties and the properties collateralizing its tax-exempt mortgage revenue bonds is in compliance, in all material respects, with federal, state and local regulations regarding hazardous waste and other environmental matters and is not aware of any environmental contamination at any of such properties that would require any material capital expenditure by the underlying properties and therefore the Partnership for the remediation thereof.

 

Tax Status

 

The Partnership is classified as a partnership for federal income tax purposes and accordingly, it makes no provision for income taxes. The distributive share of the Partnership’s income, deductions and credits is included in each BUC holder’s income tax return.

 

The Partnership’s subsidiary, Holding Corp, is a “C” corporation for income tax purposes and files a separate income tax return. Therefore, the Partnership is only subject to income taxes on this investment to the extent it receives dividends from Holding Corp.

 

The VIEs consolidated with the Partnership for GAAP reporting purposes are separate legal entities who record and report income taxes based upon their individual legal structure which may include corporations, limited partnerships and limited liability companies. The Partnership does not presently believe that the consolidation of VIEs for reporting under GAAP will impact the Partnership’s tax status, amounts reported to BUC holders on IRS Form K-1, the Partnership’s ability to distribute tax-exempt income to BUC holders, the current level of quarterly distributions or the tax-exempt status of the underlying mortgage revenue bonds.

 

General Information

 

We are a Delaware limited partnership. Our general partner is America First Capital Associates Limited Partnership 2, whose general partner is Burlington. Since 1984, Burlington has specialized in the management of investment funds, many of which were formed to acquire real estate investments such as tax-exempt mortgage revenue bonds, mortgage securities and multifamily real estate properties. Burlington maintains its principal executive offices at 1004 Farnam Street, Suite 400, Omaha, Nebraska 68102, and its telephone number is (402) 444-1630.

 

We do not have any employees of our own. Employees of Burlington, acting through our general partner, are responsible for our operations and we reimburse Burlington for the allocated salaries and benefits of these employees and for other expenses incurred in running our business operations. In connection with the operation of the Company, our general partner is entitled to an administrative fee in an amount equal to 0.45% per annum of principal amount of the revenue bonds, other tax-exempt investments and taxable mortgage loans held by the Partnership. Nine of the tax-exempt revenue bonds held by the Partnership provide for the payment of this administrative fee to the general partner by the owner of the financed property. When the administrative fee is payable by a property owner, it is subordinated to the payment of all base interest to the Partnership on the tax-exempt revenue bond on that property. Our Agreement of Limited Partnership provides that the administrative fee will be paid directly by the Partnership with respect to any investments for which the administrative fee is not payable by the property owner or a third party. In addition, our Agreement of Limited Partnership provides that the Partnership will pay the administrative fee to the general partner with respect to any foreclosed mortgage bonds.

Our general partner or its affiliates may also earn mortgage placement fees in connection with the identification and evaluation of additional investments that we acquire. Any mortgage placement fees will be paid by the owners of the properties financed by the acquired mortgage revenue bonds out of bond proceeds. The amount of mortgage placement fees, if any, will be subject to negotiation between the general partner or its affiliates and such property owners.

 

America First Properties Management Company, L.L.C. (“Properties Management”) is an affiliate of Burlington that is engaged in the management of apartment complexes. Properties Management currently manages the six MF Properties and ten of the properties whose tax-exempt bonds are held by the Partnership and earns a fee paid out of property revenues. Properties Management may also seek to become the manager of apartment complexes financed by additional mortgage bonds acquired by the Company, subject to negotiation with the owners of such properties. If the Company acquires ownership of any property through foreclosure of a revenue bond, Properties Management may provide property management services for such property and, in such case, earn a fee payable out of property revenues.

 

Our sole limited partner is America First Fiduciary Corporation Number Five, a Nebraska corporation. BUCs represent assignments by the sole limited partner of its rights and obligations as a limited partner.

 

Information Available on Website

 

The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and press releases are available free of charge at www.ataxz.com as soon as reasonably practical after they are filed with the SEC. The information on the website is not incorporated by reference into this Form 10-K.

 

 

The financial condition, results of operations and cash flows of the Partnership are affected by various factors, many of which are beyond the Partnership’s control. These include the following:

 

The receipt of interest and principal payments on our tax-exempt mortgage revenue bonds will be affected by the economic results of the underlying multifamily properties.

 

Although our tax-exempt mortgage revenue bonds are issued by state or local housing authorities, they are not obligations of these governmental entities and are not backed by any taxing authority. Instead, each of these revenue bonds is backed by a non-recourse loan made to the owner of the underlying apartment complex and is secured by a first mortgage lien on the property. Because of the non-recourse nature of the underlying mortgage loans, the sole source of cash to pay base and contingent interest, if applicable, on the revenue bond, and to ultimately pay the principal amount of the bond, is the net cash flow generated by the operation of the financed property and the net proceeds from the ultimate sale or refinancing of the property. This makes our investments in these mortgage revenue bonds subject to the kinds of risks usually associated with direct investments in multifamily real estate. If a property is unable to sustain net cash flow at a level necessary to pay its debt service obligations on our tax-exempt mortgage revenue bond on the property, a default may occur. Net cash flow and net sale proceeds from a particular property are applied only to debt service payments of the particular mortgage revenue bond secured by that property and are not available to satisfy debt service obligations on other mortgage revenue bonds that we hold. In addition, the value of a property at the time of its sale or refinancing will be a direct function of its perceived future profitability. Therefore, the amount of base and contingent interest that we earn on our mortgage revenue bonds, and whether or not we will receive the entire principal balance of the bonds as and when due, will depend to a large degree on the economic results of the underlying apartment complexes.

 

The net cash flow from the operation of a property may be affected by many things, such as the number of tenants, the rental rates, operating expenses, the cost of repairs and maintenance, taxes, government regulation, competition from other apartment complexes, mortgage rates for single-family housing and general and local economic conditions. In most of the markets in which the properties financed by our bonds are located, there is significant competition from other apartment complexes and from single-family housing that is either owned or leased by potential tenants. Low mortgage interest rates make single-family housing more accessible to persons who may otherwise rent apartments.

In the event of a default on a mortgage revenue bond (or a taxable loan on the same property), we will have the right to foreclose on the mortgage or deed of trust securing the property. If we take ownership of the property securing a defaulted revenue bond or taxable loan, we will be entitled to all net cash flow generated by the property. However, such amounts will no longer represent tax-exempt interest to us.

 

The value of the properties is the only source of repayment of our tax-exempt mortgage revenue bonds.

 

The principal of most of our tax-exempt mortgage revenue bonds does not fully amortize over their terms. This means that all or some of the balance of the mortgage loans underlying these bonds will be repaid as a lump-sum “balloon” payment at the end of the term. The ability of the property owners to repay the mortgage loans with balloon payments is dependent upon their ability to sell the properties securing our tax-exempt mortgage revenue bonds or obtain adequate refinancing. The mortgage revenue bonds are not personal obligations of the property owners, and we rely solely on the value of the properties securing these bonds for security. Similarly, if a tax-exempt mortgage revenue bond goes into default, our only recourse is to foreclose on the underlying multifamily property. If the value of the underlying property securing the bond is less than the outstanding principal balance and accrued interest on the bond, we will suffer a loss.

 

In the event a property securing a tax-exempt mortgage revenue bond is not sold prior to the maturity or remarketing of the bond, any contingent interest payable from the net sale or refinancing proceeds of the underlying property will be determined on the basis of the appraised value of the underlying property. Real estate appraisals represent only an estimate of the value of the property being appraised and are based on subjective determinations, such as the extent to which the properties used for comparison purposes are comparable to the property being evaluated and the rate at which a prospective purchaser would capitalize the cash flow of the property to determine a purchase price. Accordingly, such appraisals may result in us realizing less contingent interest from a tax-exempt mortgage revenue bond than we would have realized had the underlying property been sold.

 

There are a number of risks related to the construction of multifamily apartment properties that may affect the tax-exempt bonds issued to finance these properties.

 

Four of the tax-exempt revenue bonds the Partnership currently holds are secured by multifamily apartment properties which are still under construction. The Partnership may acquire additional tax-exempt revenue bonds issued to finance apartment properties in various stages of construction. Construction of such properties generally takes approximately 12 to 18 months. The principal risk associated with construction lending is the risk that construction of the property will be substantially delayed or never completed. This may occur for a number of reasons including (i) insufficient financing to complete the project due to underestimated construction costs or cost overruns; (ii) failure of contractors or subcontractors to perform under their agreements, (iii) inability to obtain governmental approvals; (iv) labor disputes, and (v) adverse weather and other unpredictable contingencies beyond the control of the developer. While the Partnership may be able to protect itself from some of these risks by obtaining construction completion guarantees from developers, agreements of construction lenders to purchase its bonds if construction is not completed on time, and/or payment and performance bonds from contractors, the Partnership may not be able to do so in all cases or such guarantees or bonds may not fully protect it in the event a property is not completed. In other cases, the Partnership may decide to forego certain types of available security if it determines that the security is not necessary or is too expensive to obtain in relation to the risks covered. If a property is not completed, or costs more to complete than anticipated, it may cause the Partnership to receive less than the full amount of interest owed to it on the tax-exempt bond financing such property or otherwise result in a default under the mortgage loan that secures its tax-exempt bond on the property. In such case, the Partnership may be forced to foreclose on the incomplete property and sell it in order to recover the principal and accrued interest on its tax-exempt bond and it may suffer a loss of capital as a result. Alternatively, the Partnership may decide to finance the remaining construction of the property, in which event it will need to invest additional funds into the property, either as equity or as a taxable loan. Any return on this additional investment would not be tax-exempt. Also, if the Partnership forecloses on a property, it will no longer receive tax-exempt interest on the bond issued to finance the property. In addition, the overall return to the Partnership from its investment in such property is likely to be less than if the construction had been completed on time or within budget.

There are a number of risks related to the lease-up of newly constructed or renovated properties that may affect the tax-exempt bonds issued to finance these properties.

 

Four of the tax-exempt revenue bonds the Partnership currently invests in are secured by affordable multifamily apartment properties which are still under construction. The Partnership may acquire additional tax-exempt revenue bonds issued to finance properties in various stages of construction or renovation. As construction or renovation is completed, these properties will move into the lease-up phase. The lease-up of these properties may not be completed on schedule or at anticipated rent levels, resulting in a greater risk that these investments may go into default than investments secured by mortgages on properties that are stabilized or fully leased-up. The underlying property may not achieve expected occupancy or debt service coverage levels. While the Partnership may require property developers to provide it with a guarantee covering operating deficits of the property during the lease-up phase, it may not be able to do so in all cases or such guarantees may not fully protect the Partnership in the event a property is not leased up to an adequate level of economic occupancy as anticipated.

 

There is additional credit risk when we make a taxable loan on a property.

 

Taxable mortgage loans which we make to owners of the properties which secure mortgage revenue bonds held by us are non-recourse obligations of the property owner. As a result, the sole source of principal and interest payments on these taxable loans is the net cash flow generated by these properties or the net proceeds from the sale of these properties. The net cash flow from the operation of a property may be affected by many things as discussed above. If a property is unable to sustain net cash flow at a level necessary to pay current debt service obligations on our taxable loan on such property, a default may occur. In addition, any payment of principal and interest on a taxable loan on a particular property will be subordinate to payment of all principal and interest (including contingent interest) on the mortgage revenue bond secured by the same property. As a result, there may be a higher risk of default on the taxable loans than on the mortgage revenue bonds.

 

The properties financed by our tax-exempt bonds are not completely insured against damages from hurricanes and other major storms.

 

Three of the multifamily housing properties financed by tax-exempt bonds held by the Partnership are located in Florida in areas that are prone to damage from hurricanes and other major storms. Due to the significant losses incurred by insurance companies on policies written on properties in Florida damaged by hurricanes, property and casualty insurers in Florida have modified their approach to underwriting policies. As a result, the owners of these Florida properties now assume the risk of first loss on a larger percentage of their property’s value. If any of these properties were damaged in a hurricane or other major storm, the losses incurred could be significant and would reduce the cash flow available to pay base or contingent interest on the Partnership’s tax-exempt bonds collateralized by these properties. In general, the current insurance policies on these properties carry a 3% deductible on the insurable value of the properties. The current insurable value of the Florida properties is approximately $52.2 million.

 

The Company may be adversely impacted by economic factors beyond its control and may incur impairment charges to its investment portfolio.

 

The credit and capital markets have continued to deteriorate. If uncertainties in these markets continue, the markets deteriorate further or the Company experiences deterioration in the values of its investment portfolio, the Company may incur impairments to its investment portfolio which could negatively impact the Company’s financial condition, cash flows, and reported earnings.

 

We may suffer adverse consequences from changing interest rates.

 

We have financed the acquisition of some of our assets using variable-rate debt financing. The interest that we pay on this financing fluctuates with a specific interest rate index. If the interest rate index increases, our interest expense will increase. This will reduce the amount of cash we have available for distribution and may affect the market value of our BUCs.

An increase in interest rates could also decrease the value of our tax-exempt mortgage bonds. A decrease in the value of our tax-exempt mortgage revenue bonds could cause the debt financing counterparty to demand additional collateral. If additional collateral is not available, the debt financing could be terminated and some or all of the bonds collateralizing such financing may be sold to repay the debt. In that case, we would lose the net interest income from these bonds. A decrease in the value of our tax-exempt mortgage revenue bonds could also decrease the amount we could realize on the sale of our investments and would decrease the amount of funds available for distribution to holders of BUCs.

 

There are risks associated with our participation in the P-Float program.

 

In order to obtain debt financing, we have securitized many of our tax-exempt mortgage revenue bonds through the Merrill Lynch P-Float program. Under this program, we deposit a tax-exempt mortgage revenue bond into a trust which issues a senior P-Float to an institutional investor and a residual interest to us. By using the P-Float program for debt financing, we forego a portion of the interest we would have received on our existing tax-exempt mortgage revenue bonds. If we are unable to reinvest the proceeds from this borrowing in investments that generate a greater amount of interest, the amount of net interest income that we receive may decline.

 

The trust pays interest on the P-Floats and the residual interest from the interest payments received on the underlying tax-exempt mortgage revenue bond. If the trust is unable to pay the full amount of interest due on the P-Float, a default will occur. In addition, if the value of the mortgage revenue bond and any other collateral declines below a specified level, a default will occur. In such event, the trust could be terminated and some or all of the bonds pledged as collateral may be sold to satisfy the debt.

 

In this program, the senior interests sold are credit-enhanced by Merrill Lynch or its affiliate. The inability of Merrill Lynch or its affiliate to perform under the program or impairment of the credit-enhancement may terminate the transaction and cause us to lose the net interest income earned as a result.

 

Recent credit losses and credit rating downgrades at Merrill Lynch have caused Merrill Lynch’s cost of borrowing to increase significantly. These additional costs of borrowing are passed on to the Partnership by Merrill Lynch on the Partnership’s P-Float debt. We do not expect to have access to additional debt financing through the Merrill Lynch P-Float program for the foreseeable future and there can be no assurances that we will be able to arrange alternative sources of financing. Additionally, there can be no assurances that our existing P-Float debt will remain in place even with the additional costs currently being assessed.

 

Our tax-exempt mortgage revenue bonds are illiquid assets and their value may decrease.

 

The majority of our assets consist of our tax-exempt mortgage revenue bonds. These mortgage revenue bonds are relatively illiquid, and there is no existing trading market for these mortgage revenue bonds. As a result, there are no market makers, price quotations or other indications of a developed trading market for these mortgage revenue bonds. In addition, no rating has been issued on any of the existing mortgage revenue bonds and we do not expect to obtain ratings on mortgage revenue bonds we may acquire in the future. Accordingly, any buyer of these mortgage revenue bonds would need to perform its own due diligence prior to a purchase. As a result, our ability to sell our tax-exempt mortgage revenue bonds, and the price we may receive upon their sale, will be affected by the number of potential buyers, the number of similar securities on the market at the time and a number of other market conditions. As a result, such a sale could result in a loss to us.

 

We could be adversely affected if counterparties are unable to fulfill their obligations under our derivative agreements.

 

We have used interest rate swaps and caps to help us mitigate our interest rate risks. However, these derivative transactions do not fully insulate us from the interest rate risks to which we are exposed. A liquid secondary market may not exist for any instruments purchased or sold in those transactions, thus, we may be required to maintain a position until exercise or expiration, which could result in losses. Moreover, the derivative instruments are required to be marked to market with the difference recognized in earnings as interest expense which can result in significant volatility to reported net income over the term of these instruments. The counterparty to certain of these agreements

has the right to convert them to fixed-rate agreements, and it is possible that such a conversion could result in our paying more interest than we would under our variable-rate financing.

 

The rent restrictions and occupant income limitations imposed on affordable housing properties may limit the revenues of such properties.

 

All of the properties securing our tax-exempt mortgage revenue bonds and the MF Properties are subject to certain federal, state and/or local requirements with respect to the permissible income of their tenants. Since federal subsidies are not generally available on these properties, rents must be charged on a designated portion of the units at a level to permit these units to be continuously occupied by low or moderate income persons or families. As a result, these rents may not be sufficient to cover all operating costs with respect to these units and debt service on the applicable tax-exempt mortgage revenue bond. This may force the property owner to charge rents on the remaining units that are higher than they would be otherwise and may, therefore, exceed competitive rents which may adversely affect the occupancy rate of a property securing an investment and the property owner’s ability to service its debt.

 

The MF Properties and the properties securing our revenue bonds may be subject to liability for environmental contamination and thereby increase the risk of default on such bonds.

 

The owner or operator of real property may become liable for the costs of removal or remediation of hazardous substances released on its property. Various federal, state and local laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances. The MF Properties and the properties that secure our revenue bonds, or any additional revenue bonds we acquire in the future, may contain contamination of which we are not aware. The costs associated with the remediation of any such contamination may be significant and may exceed the value of a property, causing a loss for our subsidiary or, in the case of properties securing our revenue bonds, the property owner to default on the revenue bond secured by the property.

 

Direct ownership of apartment properties will subject the Partnership to all of the risks normally associated with the ownership of commercial real estate.

 

The Partnership may acquire ownership of apartment complexes financed by tax-exempt bonds held by it in the event of a default on such bonds. Additionally, the Partnership has acquired interests in MF Properties in order to facilitate the eventual acquisition of tax-exempt mortgage revenue bonds on the properties. In either case, during the time the Partnership owns an apartment complex, it will generate taxable income or losses from the operations of such property rather than tax exempt interest. In addition, the Partnership will be subject to all of the risks normally associated with the operation of commercial real estate including declines in property value, occupancy and rental rates and increases in operating expenses. The Partnership may also be subject to government regulations, natural disasters and environmental issues, any of which could have an adverse affect on the Partnership’s financial results and ability to make distributions to BUC holders.

 

We have assumed certain potential liability relating to recapture of tax credits on MF Properties.

 

The previous partners in the partnerships that own the MF Properties have taken low income housing tax credits with respect to the acquisition or rehabilitation of these properties. In connection with the acquisition by Holdings of a partnership interest in these partnerships, we have agreed to reimburse the prior partners for any liabilities they incur due to recapture of these tax credits to the extent the recapture liability is due to the operation of the MF Properties after Holdings acquired its interest therein in a manner inconsistent with the laws and regulations relating to such tax credits.

 

Any future issuances of additional BUCs could cause their market value to decline.

 

We have the authority to issue additional BUCs representing assigned limited partner interests in the Partnership, and we plan to issue such BUCs from time to time. The issuance of additional BUCs could cause dilution of the existing BUCs and a decrease in the market price of the BUCs. If additional BUCs are issued but the

Company is unable to invest the additional equity capital in assets that generate tax-exempt income at levels at least equivalent to our existing assets, Cash Available for Distributions (“CAD”) may decline. A decline in CAD may result in lower distributions to BUC holders and a lower market price for our BUCs.

 

The Company is not registered under the Investment Company Act.

 

The Company is not required to register as an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”) because it operates under an exemption from these registration requirements. As a result, none of the protections of the Investment Company Act (disinterested directors, custody requirements for securities, and regulation of the relationship between a fund and its advisor) are applicable to the Company.

 

The Company engages in transactions with related parties.

 

Each of the executive officers of Burlington and four of the managers of Burlington hold equity positions in Burlington. A subsidiary of Burlington acts as our general partner and manages our investments and performs administrative services for us and earns certain fees that are either paid by the properties financed by our tax-exempt mortgage revenue bonds or by us. Another subsidiary of Burlington provides on-site management for the MF Properties and for many of the multifamily apartment properties that underlie our tax-exempt bonds and earns fees from the property owners based on the gross revenues of these properties. The shareholders of the limited-purpose corporations which own five of the apartment properties financed with tax-exempt bonds and taxable loans held by the Company are employees of Burlington who are not involved in the operation or management of the Company and who are not executive officers or managers of Burlington. Because of these relationships, our agreements with Burlington and its subsidiaries are related-party transactions. By their nature, related-party transactions may not be considered to have been negotiated at arm’s-length. These relationships may also cause a conflict of interest in other situations where we are negotiating with Burlington.

 

BUC holders may incur tax liability if any of the interest on our tax-exempt mortgage revenue bonds is determined to be taxable.

 

Certain of our tax-exempt mortgage revenue bonds bear interest at rates which include contingent interest. Payment of the contingent interest depends on the amount of net cash flow generated by, and net proceeds realized from a sale of, the property securing the bond. Due to this contingent interest feature, an issue may arise as to whether the relationship between the property owner and us is that of debtor and creditor or whether we are engaged in a partnership or joint venture with the property owner. If the Internal Revenue Service (“IRS”) were to determine that tax-exempt mortgage revenue bonds represented an equity investment in the underlying property, the interest paid to us could be viewed as a taxable return on such investment and would not qualify as tax-exempt interest for federal income tax purposes. We have obtained unqualified legal opinions to the effect that interest on our tax-exempt mortgage revenue bonds is excludable from gross income for federal income tax purposes which opinions provide that interest paid to a “substantial user” or “related person” (each as defined in the Code) is not exempt from federal income taxation. However, these legal opinions have no binding effect on the IRS or the courts, and no assurances can be given that the conclusions reached will not be contested by the IRS or, if contested, will be sustained by a court. In addition, the tax-exempt status of the interest paid on our tax-exempt mortgage revenue bonds is subject to compliance by the underlying properties, and the owners thereof, with the bond documents and covenants required by the bond-issuing authority and the Code. Among these requirements are tenant income restrictions, regulatory agreement compliance, reporting requirements, use of proceeds restrictions and compliance with rules pertaining to arbitrage. Each issuer of the revenue bonds, as well as each of the underlying property owners/borrowers, has covenanted to comply with procedures and guidelines designed to ensure satisfaction with the continuing requirements of the Code. Failure to comply with these continuing requirements of the Code may cause the interest on our bonds to be includable in gross income for federal income tax purposes retroactively to the date of issuance, regardless of when such noncompliance occurs. In addition, we hold residual interests issued in securitization programs which hold tax-exempt mortgage revenue bonds, such as the P-Floats/RITES program, which entitle us to a share of the tax-exempt interest of these mortgage revenue bonds. It is possible that the characterization of the residual interest in the P-Floats/RITES program could be challenged and the income that we

receive through these instruments could be treated as ordinary taxable income includable in our gross income for federal tax purposes. The rules dealing with federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Treasury Department. Changes to the tax law, which may have retroactive application, could adversely affect us and our shareholders. It cannot be predicted whether, when, in what forms or with what effective dates the tax law applicable to us will be changed.

 

Not all of the interest income of the Company is exempt from taxation.

 

We have made, and may make in the future, taxable mortgage loans to the owners of properties which are secured by tax-exempt mortgage revenue bonds that we hold. Shareholders will be taxed on their allocable share of this taxable interest income. In any case that interest earned by the Company is taxable, a shareholder’s allocable share of this taxable interest income will be taxable to the shareholder regardless of whether an amount of cash equal to such allocable share is actually distributed to the shareholder.

 

If the Company was determined not to be a partnership for tax purposes, it will have adverse economic consequences for the Company and its shareholders.

 

We are a Delaware limited partnership and have chosen to operate as a partnership for federal income tax purposes. As a partnership, to the extent we generate taxable income, shareholders will be individually liable for income tax on their proportionate share of this taxable income, whether or not we make cash distributions. The ability of shareholders to deduct their proportionate share of the losses and expenses we generate will be limited in certain cases, and certain transactions may result in the triggering of the Alternative Minimum Tax for shareholders who are individuals.

 

If the Company is classified as an association taxable as a corporation rather than as a partnership, we will be taxed on our taxable income, if any, and all distributions made by us to our shareholders would constitute ordinary dividend income taxable to such shareholders to the extent of our earnings and profits, which would include tax-exempt income, as well as any taxable income we might have, and the payment of these dividends would not be deductible by us. The listing of the Company’s BUCs for trading on the NASDAQ Global Market causes the Company to be treated as a “publicly traded partnership” under Section 7704 of the Code. A publicly traded partnership is generally taxable as a corporation unless 90% or more of its gross income is “qualifying” income. Qualifying income includes interest, dividends, real property rents, gain from the sale or other disposition of real property, gain from the sale or other disposition of capital assets held for the production of interest or dividends and certain other items. Substantially all of the Company’s gross income will continue to be tax-exempt interest income on mortgage bonds. We believe that all of this interest income is qualifying income, however, it is possible that some or all of our income could be determined not to be qualifying income. In such a case, if more than 10% of our annual gross income in any year is not qualifying income, the Company will be taxable as a corporation rather than a partnership for federal income tax purposes. We have not received, and do not intend to seek, a ruling from the IRS regarding our status as a partnership for tax purposes.

 

 

None

 

 

Each of the Partnership’s tax-exempt mortgage revenue bonds is collateralized by a multifamily housing property. The Partnership does not hold title or any other interest in these properties, other than the first mortgages securing the bonds.

 

As a result of FIN 46R, the Company is required to consolidate certain of the multifamily residential properties securing its bonds because the owners of those properties are treated as VIEs for which the Company is the primary beneficiary. The Company consolidated eight multifamily housing properties owned by VIEs located in Florida, Indiana, Iowa, South Carolina and Kentucky as of December 31, 2007.

In addition to the properties owned by VIEs, the Company reports the financial results of the MF Properties on a consolidated basis due to the 99% limited partnership interests held by its subsidiary in the partnerships that own the MF Properties. The Company consolidated six MF Properties located in Ohio and Kentucky as of December 31, 2007.

 

The following table sets forth certain information for each of the consolidated properties as of December 31, 2007:

 

 

 

 

There are no material pending legal proceedings to which the Partnership is a party or to which any of the properties collateralizing the Partnership’s tax-exempt mortgage revenue bonds are subject.

 

No matter was submitted during the fourth quarter of the fiscal year ended December 31, 2007 to a vote of the Partnership’s security holders.

 

 

(a) Market Information. BUCs represent assignments by the sole limited partner of its rights and obligations as a limited partner. The rights and obligations of BUC holders are set forth in the Partnership’s Agreement of Limited Partnership. BUCs of the Partnership trade on the NASDAQ Global Market under the trading symbol “ATAXZ”. The following table sets forth the high and low sale prices for the BUCs for each quarterly period from January 1, 2006 through December 31, 2007.

 

 

 

(b) BUC Holders. The approximate number of BUC holders on December 31, 2007 was 5,000.

 

(c) Distributions. Distributions to BUC holders were made on a quarterly basis during 2007, 2006, and 2005 with a special distribution in December 2005. Total distributions for the years ended December 31, 2007, 2006, and 2005 were $6,801,000, $5,312,000 and $7,937,000, respectively. The distributions paid or accrued per BUC during the fiscal years ended December 31, 2007, 2006, and 2005 were as follows:

 

 

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for information regarding the sources of funds that will be used for cash distributions and for a discussion of factors which may adversely affect the Partnership’s ability to make cash distributions at the same levels in 2008 and thereafter.

 

(d) Use of Proceeds from Issuance of Additional BUCs

 

Net proceeds realized by the Company from the issuance of the additional BUCs in 2007 were approximately $27.5 million, after payment of an underwriter’s discount and other offering costs of approximately $2.1 million. The proceeds were used to acquire additional tax-exempt revenue bonds and other investments meeting the Partnership’s investment criteria, and for general working capital needs.

 

(e) Sales of Unregistered Securities. None

 

(f) Issuer Purchases of Equity Securities. None

 

Set forth below is selected financial data for the Company as of and for the years ended December 31, 2004 through 2007 and for the Partnership as of and for the year ended December 31, 2003. The information should be read in conjunction with the Company’s consolidated financial statements and notes thereto filed in response to Item 8 of this report. In addition, please refer to the discussions in Item 1 and Item 7 regarding the adoption of FIN 46R and its effects on the presentation of financial data in this report on Form 10-K.

 

 

 

 

There is no generally accepted methodology for computing CAD, and the Company’s computation of CAD may not be comparable to CAD reported by other companies.

 

Although the Company considers CAD to be a useful measure of its operating performance, CAD should not be considered as an alternative to net income (loss) or net cash flows from operating activities which are calculated in accordance with GAAP.

 

The following sets forth a reconciliation of the Company’s net income (loss) as determined in accordance with GAAP and its CAD for the periods set forth.

 

 

 

 

 

General

 

In this Management’s Discussion and Analysis we will discuss the results of operations in two sections, (1) the “Company”, which refers to the consolidated financial information as reported on a GAAP basis of America First Tax Exempt Investors, L.P, its subsidiary, America First LP Holding Corp. (“Holding Corp”) and the consolidated variable interest entities (“VIEs”) as described below and (2) the “Partnership” which refers to America First Tax Exempt Investors, L.P. and Holding Corp as a stand-alone entity without the consolidation of VIEs. MF Properties refers to the multifamily apartment projects that are owned by partnerships of which the Holding Corp is the 99% limited partner and are consolidated with the Partnership. The consolidated VIEs refers to certain entities that own multifamily apartment projects financed with mortgage revenue bonds held by the Partnership that have been determined to be variable interest entities and are consolidated with the Partnership in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46R (“FIN 46R”.) Throughout this discussion we will refer to the Company, the Partnership, MF Properties and the consolidated VIEs as described in this paragraph. This discussion structure is consistent with the segment reporting of the Company as presented in the Notes to the consolidated financial statements of the Company.

 

Critical Accounting Policies

 

The preparation of financial statements in accordance with GAAP requires management of the Company to make a number of judgments, assumptions and estimates. The application of these judgments, assumptions and estimates can affect the amounts of assets, liabilities, revenues and expenses reported by the Company. All of the Company’s significant accounting policies are described in Note 2 to the Company’s consolidated financial statements included in Item 8 of this report. The Company considers the following to be its critical accounting policies because they involve judgments, assumptions and estimates by management that significantly affect the financial statements. If these estimates differ significantly from actual results, the impact on our Consolidated Financial Statements may be material.

 

Variable Interest Entities (“VIEs”)

 

When the Partnership invests in a tax-exempt mortgage revenue bond which is collateralized by the underlying multifamily property, the Partnership will evaluate the entity which owns the property securing the tax-exempt mortgage revenue bond to determine if it is a VIE as defined by FIN 46R. FIN 46R is a complex standard that requires significant analysis and judgment. If it is determined that the entity is a VIE, the Partnership will then evaluate if it is the primary beneficiary of such VIE, by determining whether the Partnership will absorb the majority of the VIE’s expected losses, receive a majority of the VIE’s residual returns, or both. If the Partnership determines itself to be the primary beneficiary of the VIE, then the assets, liabilities and financial results of the related multifamily property will be consolidated in the Partnership’s financial statements. If management incorrectly applies the provisions of FIN 46R, the Company might improperly consolidate, or fail to consolidate, an entity.

 

Purchase Accounting

 

Pursuant to SFAS No. 141, Business Combinations, the Company allocates a portion of the total acquisition cost of a property acquired to leases in existence as of the date of acquisition. The estimated valuation of in-place leases is calculated by applying a risk-adjusted discount rate to the projected cash flow deficit at each property during the lease-up of these properties. This allocated cost is amortized over the average remaining term of the leases (approximately six to twelve months) and is included in the Statement of Operations under depreciation and amortization expense.

Investments in Tax-Exempt Mortgage Revenue Bonds and Other Tax-Exempt Bonds

 

The credit and capital markets have continued to deteriorate. If uncertainties in these markets continue, the markets deteriorate further or the Company experiences deterioration in the values of its investment portfolio, the Company may incur impairments to its investment portfolio which could negatively impact the Company’s financial condition, cash flows, and reported earnings.

 

Valuation — As all of the Partnership’s investments in tax-exempt mortgage revenue bonds are classified as available-for-sale securities, they are carried on the balance sheet at their estimated fair values. The Company bases the fair value of the tax-exempt bonds, which have a limited market, on quotes from external sources, such as brokers, for these or similar bonds. In the limited situation when quotes are unavailable, the Partnership estimates the fair value for each bond as the present value of its expected cash flows using a discount rate for comparable tax-exempt investments. This calculation methodology encompasses judgment in its application.

 

As of December 31, 2007, approximately $60.0 million of the Company’s tax-exempt mortgage revenue bonds are valued using broker quotes and approximately $5.7 million are valued using management’s discounted cash flow analyses. Broker quotes and management’s discounted cash flow analyses provide indicative pricing only. Due to the limited market for the tax-exempt bonds, these estimates of fair value do not necessarily represent what the Company would actually receive in a sale of the bonds.

 

Effect of classification of securities on earnings — As the Partnership’s investments in tax-exempt mortgage revenue bonds are classified as available-for-sale securities, changes in estimated fair values are recorded as adjustments to accumulated other comprehensive income, which is a component of partners’ capital, rather than through earnings. The Partnership does not intend to hold any of its securities for trading purposes; however, if the Partnership’s available-for-sale securities were classified as trading securities, there could be substantially greater volatility in the Partnership’s earnings because changes in estimated fair values would be reflected in the Partnership’s earnings.

 

Review of securities for other-than-temporary impairment — The Partnership periodically reviews each of its mortgage revenue bonds for impairment by comparing the estimated fair value of the revenue bond to its carrying amount. The estimated fair value of the revenue bond is calculated using a discounted cash flow model using interest rates for comparable investments. A security is considered other-than-temporarily impaired if evidence indicates that the cost of the investment is not recoverable within a reasonable period of time. If an other-than-temporary impairment exists, the cost basis of the mortgage bond is written down to its estimated fair value, with the amount of the write-down accounted for as a realized loss. The recognition of an other-than-temporary impairment and the potential impairment analysis are subject to a considerable degree of judgment, the results of which when applied under different conditions or assumptions could have a material impact on the financial statements. The estimated future cash flow of each revenue bond depends on the operations of the underlying property and, therefore is subject to a significant amount of uncertainty in the estimation of future rental receipts, future real estate operating expenses, and future capital expenditures. Such estimates are affected by economic factors such as the rental markets and labor markets in which the property operates, the current capitalization rates for properties in the rental markets, and tax and insurance expenses. Different conditions or different assumptions applied to the calculation may provide different results. The Partnership periodically compares its estimates with historical results to evaluate the reasonableness and accuracy of its estimates and adjusts its estimates accordingly.

 

Revenue recognition — The interest income received by the Partnership from its tax-exempt mortgage revenue bonds is dependent upon the net cash flow of the underlying properties. Base interest income on fully performing tax-exempt mortgage revenue bonds is recognized as it is accrued. Base interest income on tax-exempt mortgage revenue bonds not fully performing is recognized as it is received. Past due base interest on tax-exempt mortgage revenue bonds, which are or were previously not fully performing, is recognized as received. The Partnership reinstates the accrual of base interest once the tax-exempt mortgage revenue bond’s ability to perform is adequately demonstrated. Contingent interest income, which is only received by the Partnership if the properties financed by the tax-exempt mortgage revenue bonds generate excess available cash flow as set forth in each bond, is recognized as received.

Derivative Instruments and Hedging Activities

 

The Partnership’s investments in interest rate cap agreements are accounted for under the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, (SFAS No. 133) as amended and interpreted. SFAS No. 133 establishes accounting and reporting standards for derivative financial instruments, including certain derivative financial instruments embedded in other contracts, and for hedging activity. SFAS No. 133 requires the Partnership to recognize all derivatives as either assets or liabilities in its financial statements and record these instruments at their fair values. In order to achieve hedge accounting treatment, hedging activities must be appropriately designated, documented and proven to be effective as a hedge pursuant to the provisions of SFAS No. 133. The Partnership did not designate its current hedges as qualifying hedges under SFAS No. 133.

 

The fair values of the caps at inception are their original cost. Changes in the fair value of the interest rate cap agreements are recognized in earnings as interest expense. The fair value adjustment through earnings can cause a significant fluctuation in reported net income although it has no impact on the Partnership’s cash flows. Although the Company utilizes current price quotes by recognized dealers as a basis for estimating the fair value of its interest rate cap agreements, the calculation of the fair value involves a considerable degree of judgment.

 

Executive Summary

 

Overview

 

The Partnership operates for the purpose of acquiring, holding, selling and otherwise dealing with a portfolio of federally tax-exempt mortgage revenue bonds which have been issued to provide construction and/or permanent financing of multifamily residential apartments. Each multifamily property financed with tax-exempt mortgage bonds held by the Partnership is owned by a separate entity. The Partnership does not hold an ownership interest in any of these entities. However, in some cases, these entities are treated as VIEs and, as a result, the assets, liabilities and financial results of the properties owned by these entities are consolidated with the Company.

 

To facilitate its investment strategy of acquiring additional tax exempt mortgage bonds secured by multifamily apartment properties, the Partnership may acquire ownership positions in apartment properties (“MF Properties”), in order to ultimately restructure the property ownership through a sale of the MF Properties and a syndication of low income housing tax credits (“LIHTCs”). The Partnership expects to ultimately restructure the property ownership through a sale of the MF Properties and a syndication LIHTCs. The Partnership expects to provide the tax-exempt mortgage revenue bonds to the new property owners as part of the restructuring. Such restructurings will generally be expected to be initiated within 36 months of the initial investment in MF Properties and will often coincide with the expiration of the compliance period relating to LIHTCs previously issued with respect to the MF Property. The Partnership will not acquire LIHTCs in connection with these transactions. As of December 31, 2007, the Partnership’s wholly-owned subsidiary, America First LP Holding Corp., held limited partnership interests in six entities that own MF Properties containing a total of 544 rental units. Until the Partnership restructures the property ownership as described above, the MF Properties operating goal is similar to that of the VIEs as described below.

 

The VIE’s operating goal is to generate increasing amounts of net rental income from these properties that will allow them to service debt. In order to achieve this goal, management of these multifamily apartment properties is focused on: (i) maintaining high economic occupancy and increasing rental rates through effective leasing, reduced turnover rates and providing quality maintenance and services to maximize resident satisfaction; (ii) managing operating expenses and achieving cost reductions through operating efficiencies and economies of scale generally inherent in the management of a portfolio of multiple properties; and (iii) emphasizing regular programs of repairs, maintenance and property improvements to enhance the competitive advantage and value of the properties in their respective market areas.

 

Ten of the 17 properties which collateralize the bonds owned by the Partnership and all of the MF Properties are managed by America First Properties Management Company (“Properties Management”), an affiliate of the Partnership. Management believes that this relationship provides greater insight and understanding of the underlying property operations and their ability to meet debt service requirements to the Partnership. The properties not

managed by Properties Management are Woodbridge Apartments of Bloomington, Woodbridge Apartments of Louisville, Bella Vista Apartments, Gardens of DeCordova, Gardens of Weatherford, Prairiebrook Village, and Runnymede Apartments.

 

At December 31, 2007, the Partnership held 20 tax exempt mortgage bonds, eight of which are secured by properties held by VIEs and, therefore, eliminated in consolidation on the Company’s financial statements. As of December 31, 2007 and 2006, the eight consolidated VIE multifamily apartment properties contained a total of 1,764 rental units. As of December 31, 2005, the Company consolidated nine VIE multifamily apartment properties containing a total of 2,256 Units. The properties underlying the nine non-consolidated tax-exempt mortgage bonds contain a total of 1,286 rental units at December 31, 2007. At December 31, 2006 and 2005, the Partnership held four non-consolidated tax-exempt mortgage bonds secured by apartment properties containing a total of 574 rental units.

 

Discussion of the Partnership Owned Apartment Properties and the Partnership Bond Holdings and the Related Apartment Properties as of December 31, 2007

 

The following discussion outlines the individual apartment properties financed by the Partnership and the MF Properties in which it holds an ownership interest and briefly discusses their overall operations and financial results. The discussion also outlines the bond holdings of the Partnership, discusses the significant terms of the bonds, identifies those ownership entities which are consolidated VIEs of the Company and briefly discusses the overall operations and financial results of the underlying properties.

 

 

 

 

Ashley Pointe — Ashley Pointe at Eagle Crest is located in Evansville, Indiana and contains 144 units. The tax-exempt mortgage revenue bonds owned by the Partnership are traditional “80/20” bonds issued prior to the Tax Reform Act of 1986. These bonds require that 20% of the rental units be set aside for tenants whose income does not exceed 80% of the area median income, without adjustment for household size. The bonds have an outstanding principal amount of $6.7 million and have a base interest rate of 7.0% per annum. The bonds also contain a participation interest in any excess cash flow generated by the underlying property through the potential payment of contingent interest. The bond accrues contingent interest at a rate of 3.5% annually and such contingent interest is payable only if the underlying property generates excess operating cash flows or realizes excess cash through capital appreciation and a related sale or refinancing of the property. To date, the property has not paid any contingent interest and the Partnership has not recognized any contingent interest income related to this bond. Because of its capital structure and the participation interests contained in the bond owned by the Partnership this property is a consolidated VIE. Ashley Pointe’s operations resulted in net operating income (calculated as property revenue less salaries, advertising, administration, utilities, repair and maintenance, insurance, taxes and management fee expenses) of $611,000 and $467,000 on net revenue of approximately $1.13 million and $1.09 million in 2007 and 2006 respectively. This improvement versus 2006 is primarily the result of increased revenue from improved occupancy and a decrease in real estate tax expense.

 

Ashley Square — Ashley Square Apartments is located in Des Moines, Iowa and contains 150 units. The tax-exempt mortgage revenue bonds owned by the Partnership are traditional “80/20” bonds issued prior to the Tax Reform Act of 1986. These bonds require that 20% of the rental units be set aside for tenants whose income does not exceed 80% of the area median income, without adjustment for household size. The bonds have an outstanding principal amount of $6.5 million and have a base interest rate of 7.5% per annum. The bonds also contain a participation interest in any excess cash flow generated by the underlying property through the potential payment of contingent interest. The bond accrues contingent interest at a rate of 3.0% annually and such contingent interest is

payable only if the underlying property generates excess operating cash flows or realizes excess cash through capital appreciation and a related sale or refinancing of the property. To date, the property has not paid any contingent interest and the Partnership has not recognized any contingent interest income related to this bond. Because of its capital structure and the participation interests contained in the bond owned by the Partnership this property is a consolidated VIE. Additionally, the equity ownership of this property is held by individuals or entities affiliated with the general partner. Ashley Square’s operations resulted in net operating income of $189,000 and $240,000 on net revenue of approximately $1.06 million and $1.07 million in 2007 and 2006 respectively. The 2007 results were negatively impacted by significant capital improvement projects which resulted in varying numbers of units being unavailable for rent throughout the year. With the completion of these projects in 2007, occupancy numbers have improved and property management expects improved operations in 2008.

 

Bella Vista — Bella Vista Apartments is located in Gainesville, Texas and contains 144 units. The tax-exempt mortgage revenue bonds owned by the Partnership are private activity housing bonds issued in conjunction with the syndication of LITHCs. The bonds have an outstanding principal amount of $6.8 million and have a base interest rate of 6.15% per annum. The bonds do not contain participation interests. We have determined that the company that owns Bella Vista Apartments does not meet the definition of a VIE. As a result, this property is not consolidated. June 2007 was the first full month of operations at Bella Vista. In 2007, Bella Vista’s operations resulted in net operating income of $400,000 on net revenue of approximately $793,000.

 

Bent Tree — Bent Tree Apartments is located in Columbia, South Carolina and contains 232 units. The tax-exempt mortgage revenue bonds owned by the Partnership are traditional “80/20” bonds issued prior to the Tax Reform Act of 1986. These bonds require that 20% of the rental units be set aside for tenants whose income does not exceed 80% of the area median income, without adjustment for household size. The bonds have an outstanding principal amount of $11.1 million and have a base interest rate of 7.1% per annum. The bonds also contain a participation interest in any excess cash flow generated by the underlying property through the potential payment of contingent interest. The bond accrues contingent interest at a rate of 1.9% annually and such contingent interest is payable only if the underlying property generates excess operating cash flows or realizes excess cash through capital appreciation and a related sale or refinancing of the property. To date, the property has not paid any contingent interest and the Partnership has not recognized any contingent interest income related to this bond. Because of its capital structure and the participation interests contained in the bond owned by the Partnership this property is a consolidated VIE. Additionally, the equity ownership of this property is held by individuals or entities affiliated with the general partner. Bent Tree’s operations resulted in net operating income of $685,000 and $580,000 on net revenue of approximately $1.53 million and $1.46 million in 2007 and 2006 respectively. This increase in net operating income is the result of increased revenue due to an increase in occupancy and other miscellaneous revenues as well as a decrease in salary expenses versus 2006.

 

Chandler Creek — Chandler Creek Apartments is located in Round Rock, Texas and contains 216 units. The tax-exempt mortgage revenue bonds owned by the Partnership were issued under Section 145 of the Code by a not-for-profit entity qualified under Section 501(c) 3 of the Code. The Chandler Creek bonds are in technical default and interest is being paid on these bonds at a base rate below the stated rate. In January 2004, the Company entered into a forbearance agreement with the owner of Chandler Creek Apartments which set forth the terms under which the Company agreed to forbear from the exercise of remedies against the owner. Among the conditions to forbearance is an agreement for current interest payments at a rate below the stated rate. In April 2006, the Company terminated the forbearance agreement with the owner. The termination of the forbearance agreement allows the Company to seek additional remedies including the ultimate foreclosure of the property, if necessary. The Company does not currently intend to exercise its right to foreclose on the property as the property continues to pursue alternatives to ultimately satisfy its obligations to its creditors. The bonds have an outstanding principal amount of $11.5 million and are currently paying a base interest rate of 6.0% per annum. The bonds do not contain participation interests. Because the property is owned by a 501(c) 3 not-for-profit entity it is not a VIE. Chandler Creek’s operations resulted in net operating income of $1.1 million and $788,000 on net revenue of approximately $1.9 million and $1.7 million in 2007 and 2006 respectively. The increase in net operating income is due to increased fee revenues and a decrease in professional fees.

 

Clarkson College — Clarkson College is a 142 bed student housing facility located in Omaha, Nebraska. The tax-exempt mortgage revenue bonds owned by the Partnership were issued under Section 145 of the Code by a not-

for-profit entity qualified under Section 501(c) 3 of the Code. The bonds have an outstanding principal amount of $6.1 million and have a base interest rate of 6.0% per annum. The bonds also contain a participation interest in any excess cash flow generated by the underlying property through the potential payment of contingent interest. The bonds accrue contingent interest at a rate of 1.25% annually and such contingent interest is payable only if the underlying property generates excess operating cash flows or realizes excess cash through capital appreciation and a related sale or refinancing of the property. To date, the property has not paid any contingent interest and the Partnership has not recognized any contingent interest income related to this bond. Because the property is owned by a 501(c)(3) not-for-profit entity it is not a VIE. Clarkson College’s operations resulted in net operating income of $499,000 and $393,000 on net revenue of approximately $695,000 and $588,000 in 2007 and 2006 respectively. As shown in the table above, occupancy trends are positive as economic occupancy increased from 2006 to 2007 driving the increased net operating income.

 

Crescent Village — Crescent Village Townhomes is located in Cincinnati, Ohio and contains 90 units. Crescent Village is one of the MF Properties consolidated with the Partnership. Accordingly, there are no tax-exempt bonds currently secured by this property. Crescent Village has realized approximately $190,000 in net operating income on revenue of $386,000 since its acquisition on June 29, 2007.

 

Deerfield — Deerfield Apartments is located in Blair, Nebraska and contains 72 units. The tax-exempt mortgage revenue bonds owned by the Partnership were issued under Section 145 of the Code by a not-for-profit entity qualified under Section 501(c) 3 of the Code. The Series A bonds have an outstanding principal amount of $3.3 million and have a base interest rate of 6.25% per annum. The Series B bonds have an outstanding principal amount of $90,000 and have a base interest rate of 8.5% per annum The bonds do not contain participation interests. Because the property is owned by a 501(c) 3 not-for-profit entity it is not a consolidated VIE. In 2007, Deerfield’s operations resulted in net operating income of $224,000 on net revenue of approximately $408,000. These bonds were purchased in the fourth quarter of 2006.

 

Eagle Ridge — Eagle Ridge Townhomes is located in Erlanger, Kentucky and contains 64 units. Eagle Ridge is one of the MF Properties consolidated with the Partnership. Accordingly, there are no tax-exempt bonds currently secured by this property. Eagle Ridge has realized approximately $109,000 in net operating income on revenue of $230,000 since its acquisition on June 29, 2007.

 

Fairmont Oaks — Fairmont Oaks Apartments is located in Gainesville, Florida and contains 178 units. The tax-exempt mortgage revenue bonds owned by the Partnership are traditional “80/20” bonds issued prior to the Tax Reform Act of 1986. These bonds require that 20% of the rental units be set aside for tenants whose income does not exceed 80% of the area median income, without adjustment for household size. The bonds have an outstanding principal amount of $7.8 million and have a base interest rate of 6.2% per annum. The bonds also contain a participation interest in any excess cash flow generated by the underlying property through the potential payment of contingent interest. The bond accrues contingent interest at a rate of 2.2% annually and such contingent interest is payable only if the underlying property generates excess operating cash flows or realizes excess cash through capital appreciation and a related sale or refinancing of the property. To date, the property has not paid any contingent interest and the Partnership has not recognized any contingent interest income related to this bond. Because of its capital structure and the participation interests contained in the bond owned by the Partnership this property is a consolidated VIE. Additionally, the equity ownership of this property is held by individuals or entities affiliated with the general partner. Fairmont Oak’s operations resulted in net operating income of $808,000 and $643,000 on net revenue of approximately $1.6 million and $1.4 million in 2007 and 2006 respectively. The increase in net operating income is a direct result of increased economic occupancy.

 

Gardens of DeCordova — The Gardens of DeCordova Apartments is currently under construction in Granbury, Texas and will contain 76 units upon completion. The Partnership owns the tax-exempt mortgage revenue bonds financing this project. Based on the construction schedule, finished units are expected to be available for leasing starting in April 2008 with a final completion of the project expected by November 2008. The developer and principals have guaranteed completion and stabilization of the project. The general contractor has a guaranteed maximum price contract and payment and performance bonds are in place. The project has an additional five months of capitalized interest reserve sufficient to fund debt service beyond the expected date of completion.

Gardens of Weatherford — The Gardens of Weatherford Apartments is currently under construction in Weatherford, Texas and will contain 76 units upon completion. The Partnership owns the tax-exempt mortgage revenue bonds financing this project. The estimated completion date is November 2008 with some units available for rent prior to that date. The developer and principals have guaranteed completion and stabilization of the project. The general contractor has a guaranteed maximum price contract and payment and performance bonds are in place. The project has an additional two months of capitalized interest reserve sufficient to fund debt service beyond the expected date of completion.

 

Iona Lakes — Iona Lakes Apartments is located in Fort Myers, Florida and contains 350 units. The tax-exempt mortgage revenue bonds owned by the Partnership are traditional “80/20” bonds issued prior to the Tax Reform Act of 1986. These bonds require that 20% of the rental units be set aside for tenants whose income does not exceed 80% of the area median income, without adjustment for household size. The bonds have an outstanding principal amount of $16.4 million and have a base interest rate of 6.9% per annum. The bonds also contain a participation interest in any excess cash flow generated by the underlying property through the potential payment of contingent interest. The bond accrues contingent interest at a rate of 2.6% annually and such contingent interest is payable only if the underlying property generates excess operating cash flows or realizes excess cash through capital appreciation and a related sale or refinancing of the property. To date, the property has not paid any contingent interest and the Partnership has not recognized any contingent interest income related to this bond. Because of its capital structure and the participation interests contained in the bond owned by the Partnership this property is a consolidated VIE. Additionally, the equity ownership of this property is held by individuals or entities affiliated with the general partner. Iona Lake’s operations resulted in net operating income of $1.1 million and $1.6 million on net revenue of approximately $2.6 million and $3.2 million in 2007 and 2006 respectively. As shown in the table above, occupancy trends were lower in 2007 which directly impacted operating results. The decline in occupancy resulted from a number of month-to-month tenants returning to their hurricane damaged homes as repairs were completed and has not recovered due to local market conditions.

 

Lake Forest — Lake Forest Apartments is located in Daytona Beach, Florida and contains 240 units. The tax-exempt mortgage revenue bonds owned by the Partnership are traditional “80/20” bonds issued prior to the Tax Reform Act of 1986. These bonds require that 20% of the rental units be set aside for tenants whose income does not exceed 80% of the area median income, without adjustment for household size. The bonds have an outstanding principal amount of $10.2 million and have a base interest rate of 6.9% per annum. The bonds also contain a participation interest in any excess cash flow generated by the underlying property through the potential payment of contingent interest. The bond accrues contingent interest at a rate of 1.6% annually and such contingent interest is payable only if the underlying property generates excess operating cash flows or realizes excess cash through capital appreciation and a related sale or refinancing of the property. To date, the property has paid approximately $231,000 of contingent interest, representing all of the contingent interest income recognized by the Partnership in 2007. Because of its capital structure and the participation interests contained in the bond owned by the Partnership this property is a consolidated VIE. Additionally, the equity ownership of this property is held by individuals or entities affiliated with the general partner. Lake Forest’s operations resulted in net operating income of $1.1 million and $1.2 million on net revenue of approximately $2.07 million and $2.14 million in 2007 and 2006 respectively.

 

Meadowview — Meadowview Apartments is located in Highland Heights, Kentucky and contains 118 units. Meadowview is one of the MF Properties consolidated with the Partnership. Accordingly, there are no tax-exempt bonds currently secured by this property. Meadowview has realized approximately $190,000 in net operating income on revenue of $429,000 since its acquisition on June 29, 2007.

 

Prairiebrook Village — In June 2007, the Company acquired the Prairiebrook Village bonds. The bonds were issued in order to construct a 72 unit multifamily apartment complex in Gardner, Kansas. On February 11, 2008, the bond trustee notified the owner and developer of Prairiebrook Village that they were not in compliance with certain sections of the bond indenture. The occurrence and continuation of this non-compliance could become an event of default. The Partnership is currently working with the trustee, developer, and owners of the project to develop an action plan. Should the non-compliance become an event of default, the Partnership will exercise all remedies at its disposal including recovering all moneys still on deposit with the trustee, sale of all assets owned by the project, and will pursue owner and developer guarantees. The Partnership anticipates that, should it have to exercise its remedies, amounts recovered will be sufficient to repay the par amount of the bonds.

Postwoods I — Postwoods Townhomes is located in Reynoldsburg, Ohio and contains 92 units. Postwoods I is one of the MF Properties consolidated with the Partnership. Accordingly, there are no tax-exempt bonds currently secured by this property. Postwoods I has realized approximately $160,000 in net operating income on revenue of $349,000 since its acquisition on June 29, 2007.

 

Postwoods II — Postwoods Townhomes is located in Reynoldsburg, Ohio and contains 88 units. Postwoods II is one of the MF Properties consolidated with the Partnership. Accordingly, there are no tax-exempt bonds currently secured by this property. Postwoods II has realized approximately $109,000 in net operating income on revenue of $303,000 since its acquisition on June 29, 2007.

 

Runnymede Apartments — Runnymede Apartments is located in Austin, Texas and contains 252 units. The tax-exempt mortgage revenue bonds owned by the Partnership are private activity housing bonds issued in conjunction with the syndication of LITHCs. The bonds have an outstanding principal amount of $10.8 million and have a base interest rate of 6.00%. The bonds do not contain participation interests. We have determined that the company that owns Runnymede Apartments does not meet the definition of a VIE. As a result, this property is not consolidated. These bonds were purchased in October 2007, as such full year operating results are not available.

 

Willow Bend — Willow Bend Townhomes is located in Columbus (Hilliard), Ohio and contains 92 units. Willow Bend is one of the MF Properties consolidated with the Partnership. Accordingly, there are no tax-exempt bonds currently secured by this property. Willow Bend has realized approximately $162,000 in net operating income on revenue of $369,000 since its acquisition on June 29, 2007.

 

Woodbridge at Bloomington — Woodbridge Apartments at Bloomington is located in Bloomington, Indiana and contains 280 units. The tax-exempt mortgage revenue bonds owned by the Partnership are traditional “80/20” bonds issued prior to the Tax Reform Act of 1986. These bonds require that 20% of the rental units be set aside for tenants whose income does not exceed 80% of the area median income, without adjustment for household size. The bonds have an outstanding principal amount of $12.6 million and have a base interest rate of 7.5% per annum. The bonds also contain a participation interest in any excess cash flow generated by the underlying property through the potential payment of contingent interest. The bond accrues contingent interest at a rate of 3.5% annually and such contingent interest is payable only if the underlying property generates excess operating cash flows or realizes excess cash through capital appreciation and a related sale or refinancing of the property. To date, the property has not paid any contingent interest and the Partnership has not recognized any contingent interest income related to this bond. Because of its capital structure and the participation interests contained in the bond owned by the Partnership this property is a consolidated VIE. Woodbridge at Bloomington’s operations resulted in net operating income of $1.1 million and $1.0 million on net revenue of approximately $2.3 million and $2.2 million in 2007 and 2006 respectively. As shown in the table above, occupancy trends are positive as physical occupancy remained high and economic occupancy increased from 2006 to 2007. The increase in net operating income is a direct result of a decrease in real estate taxes.

 

Woodbridge at Louisville — Woodbridge Apartments at Louisville is located in Louisville, Kentucky and contains 190 units. The tax-exempt mortgage revenue bonds owned by the Partnership are traditional “80/20” bonds issued prior to the Tax Reform Act of 1986. These bonds require that 20% of the rental units be set aside for tenants whose income does not exceed 80% of the area median income, without adjustment for household size. The bonds have an outstanding principal amount of $9.0 million and have a base interest rate of 7.5% per annum. The bonds also contain a participation interest in any excess cash flow generated by the underlying property through the potential payment of contingent interest. The bond accrues contingent interest at a rate of 3.5% annually and such contingent interest is payable only if the underlying property generates excess operating cash flows or realizes excess cash through capital appreciation and a related sale or refinancing of the property. To date, the property has not paid any contingent interest and the Partnership has not recognized any contingent interest income related to this bond. Because of its capital structure and the participation interests contained in the bond owned by the Partnership this property is a consolidated VIE. Woodbridge at Louisville’s operations resulted in net operating income of $749,000 and $755,000 on net revenue of approximately $1.7 million and $1.6 million in 2007 and 2006 respectively.

 

Woodland Park — Woodland Park Apartments is currently under construction in Topeka, Kansas and will contain 236 units upon completion. The Partnership owns the tax-exempt mortgage revenue bonds financing this

project. Based on the construction schedule, finished units are expected to be available for leasing starting in May 2008 with a final completion of the project expected by May 2009. The developer and principals have guaranteed completion and stabilization of the project. The general contractor has a guaranteed maximum price contract and payment and performance bonds are in place. The project has an additional four months of capitalized interest reserve sufficient to fund debt service beyond the expected date of completion.

 

The Company has determined that the underlying entities that own the Runnymede Apartments, Prairiebrook Village Apartments, Woodland Park Apartments, the Gardens of DeCordova Apartments, the Gardens of Weatherford Apartments, Clarkson College, Chandler Creek Apartments, Bella Vista Apartments, and the Deerfield Apartments which are financed by bonds owned by the Partnership do not meet the definition of a VIE and accordingly, their financial statements are not required to be consolidated into the Company’s consolidated financial statements under FIN 46R.

 

Results of Operations

 

The Consolidated Company

 

The tables below compare the results of operations for the Company for 2007, 2006, and 2005:

 

 

Year Ended December 31, 2007 Compared to the Year Ended December 31, 2006

 

Property Revenues.  Property revenues increased approximately $2.1 million for the year ended December 31, 2007 compared to the same period of 2006. The increase is attributable to the acquisition of the MF Properties which had 2007 revenue of approximately $2.1 million. Annual net rental revenues per unit related to the VIE’s decreased from approximately $7,632 in 2006 to approximately $7,534 in 2007, or $98 per unit. Annual net rental revenues per unit related to the MF Properties were, on an annualized basis, $7,427 per unit in 2007.

Mortgage revenue bond investment income.  The increase in mortgage revenue bond investment income from 2006 to 2007 is primarily due to income generated by the tax-exempt mortgage bonds acquired in 2007 plus a full year of income from bonds acquired during 2006. In 2007, a total of seven new bond investments were acquired with a total carrying value of approximately $42.0 million as of December 31, 2007. Income from these new investments accounted for $1.3 million of the total increase. The remaining increase is attributable to a full year of income on bond investments acquired in 2006.

 

Other interest income.  Other interest income represents interest earned on cash and cash equivalents. The increase is attributable to higher average balances of cash and cash equivalents during the year which resulted from the issuance of additional BUCs in April 2007.

 

Real estate operating expenses.  Real estate operating expenses increased approximately $1.3 million during 2007 compared to 2006. This increase is primarily attributable to the purchase of the MF Properties which had operating expenses of approximately $1.2 million.

 

Depreciation and amortization.  Depreciation and amortization increased approximately $1.7 million in 2007 compared to 2006. Depreciation is primarily associated with the apartment properties of the consolidated VIEs and the MF Properties. Amortization is primarily associated with in-place lease assets recorded as part of the purchase accounting for the acquisition of the MF Properties. Depreciation and amortization related to the MF Properties accounted for the majority of the increase as depreciation expense on the MF Properties was approximately $459,000 and amortization related to the MF Properties was approximately $984,000 in 2007.

 

Interest expense.  Interest expense increased approximately $1.4 million during 2007 compared to 2006 due to higher levels of borrowing and the mark-to-market adjustments on our interest rate caps. Total outstanding debt increased from approximately $45.8 million at December 31, 2006 to approximately $91.3 million as of December 31, 2007. Interest expense on the new debt accounted for approximately $1.3 million of the overall increase. The remaining increase is attributable to the effect of interest rate cap expense which is the result of marking our interest rate caps to fair value plus amortization of premiums paid for the caps. For the year ended December 31, 2006, this fair value adjustment increased interest expense by $210 as compared to an increase in interest expense in 2007 of $74,000.

 

General and administrative expenses.  General and administrative expenses were consistent between 2007 and 2006.

 

Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

 

Property Revenues.  Property revenues increased approximately $296,000 for the year ended December 31, 2006 compared to the same period of 2005. The increase is primarily attributable to an increase in net rental revenue resulting from the increase in economic occupancy. Annual net rental revenues per unit increased from approximately $7,529 in 2005 to approximately $7,632 in 2006, or $103 per unit. The largest increases in per unit rents were realized at Woodbridge Apartment of Bloomington, Woodbridge Apartments of Louisville and Lake Forest where the properties combined to increase rental revenues by approximately $234,000 or $319 per unit for the year ended December 31, 2006 compared to 2005.

 

Mortgage revenue bond investment income.  The increase in mortgage revenue bond investment income from 2005 to 2006 is primarily due to income generated by the tax-exempt mortgage bonds acquired in 2006. Specifically, the Bella Vista and Deerfield bonds were acquired in the second and fourth quarters of 2006, respectively. The interest income from Bella Vista accounted for most of the increase.

 

Other interest income.  Other interest income represents interest earned on cash and cash equivalents. The increase is attributable to higher average balances of cash and cash equivalents during the year which resulted from the Clear Lake and Northwoods transactions.

 

Gain on sale of securities.  The Company sold its entire interest in the Museum Tower bonds during the first quarter of 2005 realizing a gain on the sale of securities of $126,750. There were no such sales of securities in 2006.

 

Real estate operating expenses.  Real estate operating expenses increased during 2006 compared to 2005. This increase is related to spending on ongoing repairs and maintenance in order to make the properties more

attractive to current and potential tenants. Additionally, the properties realized increased professional services fees, real estate taxes and insurance costs.

 

Depreciation and amortization.  Depreciation and amortization consists primarily of depreciation associated with the apartment properties of the consolidated VIEs. The decrease in depreciation expense in 2006 is attributable to certain assets becoming fully depreciated during the year.

 

Interest expense.  Interest expense increased significantly when comparing 2006 to 2005 due mainly to increased interest rates on our variable interest debt and the mark-to-market adjustments on our interest rate caps. The effective borrowing rates for the year on our variable interest debt increased approximately 1%, or $477,000. The remaining increase is attributable to the effect of interest rate cap expense which is the result of marking our interest rate caps to market plus amortization of premiums paid for the caps. For the year ended December 31, 2005 this mark-to-market adjustment reduced interest expense by $365,000 as compared to an increase in interest expense in 2006 of $210.

 

General and administrative expenses.  General and administrative expenses declined during 2006 compared to the same period in 2005 primarily as a result of the payment of $359,000 of deferred administrative fees in 2005. These fees were previously deferred by the general partner, however, in conjunction with the sale of Clear Lake Colony Apartments, these fees were paid in December 2005. There were no such deferred fees paid in 2006. Additionally, salaries and benefits expense decreased approximately $90,000 for the year ended December 31, 2006 compared to 2005 due mainly to lower bonus accruals and lower benefit costs.

 

The Partnership

 

The Partnership was formed for the primary purpose of acquiring, holding, selling and otherwise dealing with a portfolio of federally tax-exempt mortgage revenue bonds which have been issued to provide construction and/or permanent financing of multifamily residential apartments. The Partnership’s business objectives are to: (i) preserve and protect its capital; (ii) provide regular cash distributions to BUC holders; and (iii) provide a potential for an enhanced federally tax-exempt yield as a result of a participation interest in the net cash flow and net capital appreciation of the underlying real estate properties financed by the tax-exempt mortgage revenue bonds.

 

The Partnership is pursuing a business strategy of acquiring additional tax-exempt mortgage revenue bonds on a leveraged basis in order to: (i) increase the amount of tax-exempt interest available for distribution to its BUC holders; (ii) reduce risk through asset diversification and interest rate hedging; and (iii) achieve economies of scale. The Partnership seeks to achieve its investment growth strategy by investing in additional tax-exempt mortgage revenue bonds and related investments, taking advantage of attractive financing structures available in the tax-exempt securities market and entering into interest rate risk management instruments.

 

Each of the tax-exempt mortgage revenue bonds bears tax-exempt interest at a fixed rate and ten of the bonds provide for the payment of additional contingent interest that is payable solely from available net cash flow generated by the financed property. At December 31, 2007, all of the Partnership’s tax-exempt mortgage revenue bonds, with the exemption of Chandler Creek, were paying their full amount of base interest. The Partnership has the ability and may restructure the terms of its tax-exempt mortgage revenue bond to reduce the base interest rate payable on these bonds. The Partnership remains aware of this potential and continues to monitor the performance of the multifamily properties collateralizing its tax-exempt mortgage revenue bonds.

 

The Partnership has financed the acquisition of tax-exempt mortgage revenue bonds through the securitization of certain of its tax-exempt mortgage revenue bonds under the Merrill Lynch P-Float program. As of December 31, 2007 the Partnership has securitized $71.4 million of its tax-exempt mortgage revenue bond portfolio. See the discussion of Liquidity and Capital Resources below for further discussion.

 

The Partnership may make taxable loans or acquire direct ownership interests in real property with the ultimate purpose of acquiring tax-exempt mortgage revenue bonds secured by the same property. The Partnership may also make taxable loans to provide capital project funding to a property securing a tax-exempt mortgage revenue bond already owned by the Partnership. Therefore, the business purpose of the Partnership making taxable loans or acquiring direct property ownership interests is not solely to earn taxable income, but rather to acquire, either

immediately or in the future, a tax-exempt mortgage revenue bond or to improve the condition of a property securing a tax-exempt mortgage revenue bond.

 

As of December 31, 2007, the Partnership’s wholly-owned subsidiary, Holding Corp., held limited partnership interests in six entities that own MF Properties containing a total of 544 rental units. As noted above, the Partnership expects to ultimately restructure the property ownership through a sale of the MF Properties and a syndication of the associated LIHTCs. The Partnership expects to provide the tax-exempt mortgage revenue bonds to the new property owners as part of the restructuring. Until such a restructuring occurs the operations of the properties owned by the limited partnerships are consolidated with the Partnership.

 

The following discussion of the Partnership’s results of operations for the years ended December 31, 2007, 2006 and 2005 reflects the operations of the Partnership without the consolidation of the VIEs required by FIN 46R. This information reflects the information used by management to analyze the Partnership’s operations and is reflective of the segment data discussed in Note 13 to the financial statements.

 

 

Year Ended December 31, 2007 Compared to the Year Ended December 31, 2006

 

Mortgage revenue bond investment income.  Mortgage revenue bond investment income decreased approximately $2.3 million in 2007 compared to 2006. The decrease is due to decreased collections of contingent interest offset by increased collections of base interest. Contingent interest income recognized in 2007 was approximately $231,000 compared to approximately $4.3 million in 2006, all of which was a result of the receipt of previously unrecognized contingent interest associated with the Partnership’s previous investment in the Northwoods Lake mortgage revenue bond. Due to the uncertainty in collections of contingent interest, the Partnership recognizes this as income only when it is realized. Base interest income on bonds increase approximately $1.8 million in 2007 as interest associated with the mortgage revenue bonds acquired in 2007 was approximately $1.3 million. A full year of interest income on bonds acquired in 2006 accounted for the remaining increase in base interest.

 

Other interest income.  Other interest income represents interest earned on the Partnership’s taxable loans and cash and cash equivalents. The decrease is attributable to a decline in interest received on taxable loans offset by

an increase in income on cash equivalent investments. Interest on taxable loans decreased approximately $646,000. The interest on taxable loans is recorded as received due to the risk of collection. Interest income on cash equivalents increased approximately $415,000 due to higher levels of cash equivalents during the year.

 

Real estate operating expenses.  Real estate operating expenses increased during 2007 as a direct result of the purchase of the MF Properties which had operating expenses of approximately $1.2 million.

 

Depreciation and amortization.  Depreciation and amortization consists primarily of depreciation and amortization associated with the MF Properties acquired in 2007.

 

Interest expense.  Interest expense increased approximately $1.4 million during 2007 compared to 2006 due to higher levels of borrowing and the mark-to-market adjustments on our interest rate caps. Total outstanding debt increased from approximately $45.8 million at December 31, 2006 to approximately $91.3 million as of December 31, 2007. Interest expense on the new debt accounted for approximately $1.3 million of the overall increase. The remaining increase is attributable to the effect of interest rate cap expense which is the result of marking our interest rate caps to market plus amortization of premiums paid for the caps. For the year ended December 31, 2006 this mark-to-market adjustment increased interest expense by $210 as compared to an increase in interest expense in 2007 of $74,000.

 

General and administrative expenses.  General and administrative expenses were consistent between 2007 and 2006.

 

Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

 

Mortgage revenue bond investment income.  Mortgage revenue bond investment income increased approximately $1.4 million in 2006 compared to 2005. The increase is due to increased collections of contingent interest offset by decreased collections of base interest. Contingent interest income collected in 2006 increased approximately $2.2 million. Previously unrecognized contingent interest associated with the Partnership’s investment in the Northwoods Lake mortgage revenue bond amounted to $4.3 million and was received and recognized in the third quarter of 2006. Previously unrecognized contingent interest associated with the Clear Lake bonds totaling approximately $2.1 million was received and recognized in the fourth quarter of 2005. Due to the uncertainty in collections of contingent interest, the Partnership recognizes this as income only when it is realized. Interest associated with the mortgage revenue bonds acquired in 2006 increased base income by approximately $360,000. Offsetting the increase associated with the new bonds were decreases in mortgage revenue bond investment income related to bonds sold or otherwise disposed in 2006 and 2005. The decrease in base interest on the Northwoods bonds which were outstanding through August 24, 2006 and the Clear Lake bonds which were outstanding through November 15, 2005 amounted to approximately $1.1 million.

 

Other interest income.  Other interest income represents interest earned on the Partnership’s taxable loans and cash and cash equivalents. The increase is attributable to interest received on taxable loans plus increase income on cash equivalent investments. Interest on taxable loans increased approximately $91,000. The interest on taxable loans is recorded as received due to the risk of collection. Interest income on cash equivalents increased approximately $337,000 due to higher levels of cash equivalents during the year.

 

Provision for loan losses.  The Partnership is required to recognize a provision for loan losses against earnings when it determines that the full amount of principal and interest on its taxable loans may not be fully recoverable. The Partnership recorded a provision for loan losses of $734,000 in 2005. No such expense was recorded in 2006.

 

Interest expense.  Interest expense decreased by approximately $43,000 during 2006 compared to 2005. The decrease is attributable to interest expense on loans outstanding during 2005 related to Clear Lake Colony Apartments which were no longer outstanding in 2006. Total interest expense paid in 2005 related to Clear Lake, including origination fees of $160,000 paid on a bridge loan used to facilitate the sale of the Clear Lake property, was approximately $777,000. Offsetting the decline in interest paid related to Clear Lake were two items, an increase in our variable borrowing rates and the mark-to-market adjustment recorded related to our interest rate caps. The effective borrowing rates for the year on our variable interest debt increased approximately 1%, or $477,000. The remaining increase is attributable to the effect of interest rate cap expense which is the result of

marking our interest rate caps to market plus amortization of premiums paid for the caps. For the year ended December 31, 2005 this mark-to-market adjustment reduced interest expense by $365,000 as compared to an increase in interest expense in 2006 of $210.

 

General and administrative expenses.  General and administrative expenses declined during 2006 compared to the same period in 2005 primarily as a result of the payment of $359,000 of deferred administrative fees in 2005. These fees were previously deferred by the general partner, however, in conjunction with the sale of Clear Lake Colony Apartments, these fees were paid in December 2005. There were no such deferred fees paid in 2006. Salaries and benefits expense decreased approximately $90,000 for the year ended December 31, 2006 compared to 2005 due mainly to lower bonus accruals and lower benefit costs. Professional and Board of Managers fees increased by approximately $60,000 due mainly to increased legal costs offset by a decline in Board of Managers fees. Along with the items noted, miscellaneous other administrative expenses showed general declines in 2006.

 

Liquidity and Capital Resources

 

Partnership Liquidity

 

Tax-exempt interest earned on the mortgage revenue bonds, including those financing properties held by VIEs, represents the Partnership’s principal source of cash flow. The Partnership may also receive cash distributions from equity interests held in MF Properties. Tax-exempt interest is primarily comprised of base interest payments received on the Partnership’s tax-exempt mortgage revenue bonds. Certain of the tax-exempt mortgage revenue bonds may also generate payments of contingent interest to the Partnership from time to time when the underlying apartment properties generate excess cash flow. Since base interest on each of the Partnership’s mortgage revenue bonds is fixed, the Partnership’s cash receipts tend to be fairly constant period to period unless the Partnership acquires or disposes of its investments in tax-exempt bonds. Changes in the economic performance of the properties financed by tax-exempt bonds with a contingent interest provision will affect the amount of contingent interest, if any, paid to the Partnership. The economic performance of a multifamily apartment property depends on the rental and occupancy rates of the property and on the level of operating expenses. Occupancy rates and rents are directly affected by the supply of, and demand for, apartments in the market area in which a property is located. This, in turn, is affected by several factors such as local or national economic conditions, the amount of new apartment construction and the affordability of single-family homes. In addition, factors such as government regulation (such as zoning laws), inflation, real estate and other taxes, labor problems and natural disasters can affect the economic operations of an apartment property. The primary uses of cash by apartment properties are: (i) the payment of operating expenses; and (ii) the payment of debt service. Other sources of cash include debt financing and the sale of additional BUCs.

 

The Partnership’s principal uses of cash are the payment of distributions to BUC holders, interest and principal on debt financing and general and administrative expenses. The Partnership also uses cash to acquire additional investments. Distributions to BUC holders may increase or decrease at the determination of the General Partner. The Partnership is currently paying distributions at the rate of $0.54 per BUC per year. The General Partner determines the amount of the distributions based upon the projected future cash flows of the Partnership. Future distributions to BUC holders will depend upon the amount of base and contingent interest received on its tax-exempt mortgage revenue bonds and cash received from other investments (including MF Properties), the amount of its borrowings and the effective interest rate these borrowings, and the amount of the Partnership’s undistributed cash.

 

In January 2007, the Company filed a Registration Statement on Form S-3 with the SEC relating to the sale of up to $100.0 million of its BUCs. The Company intends to issue BUCs from time to time under this Registration Statement to raise additional equity capital as needed to fund investment opportunities. Raising additional equity capital for deployment into new investment opportunities is part of our overall growth strategy outlined above. Pursuant to this Registration Statement, in April 2007 the Company issued, through an underwritten public offering, a total of 3,675,000 BUCs at a public offering price of $8.06 per BUC. Net proceeds realized by the Company from the issuance of the additional BUCs were approximately $27.5 million, after payment of an underwriter’s discount and other offering costs of approximately $2.1 million. The proceeds were used to acquire additional tax-exempt

revenue bonds and other investments meeting the Partnership’s investment criteria, and for general working capital needs.

 

The credit and capital markets have continued to deteriorate. If uncertainties in these markets continue, the markets deteriorate further or the Company experiences deterioration in the values of its investment portfolio, the Company may incur impairments to its investment portfolio which could negatively impact the Company’s financial condition, cash flows, and reported earnings.

 

Although the consequences of the credit issues experienced recently by the single-family subprime mortgage industry are not fully known, we do not anticipate that our existing assets will be adversely affected by these events. The Company does not issue mortgage loans secured by mortgages on single-family residential properties. In addition, we believe that additional demand for affordable rental housing may be created if there are continued defaults on subprime single family mortgages and a general contraction of credit available for single family mortgage loans. Additional demand for rental housing may have a positive economic effect on apartment properties financed by the tax-exempt bonds held by the Company. While we believe the current tightening of credit may also create opportunities for additional investments consistent with the Company’s investment strategy because there may be fewer parties competing to acquire tax-exempt bonds issued to finance affordable housing there can be no assurance that we will be able to finance the acquisition of additional tax-exempt mortgage revenue bonds through either additional equity or debt financing.

 

VIE Liquidity

 

The VIEs’ primary source of cash is net rental revenues generated by their real estate investments. Net rental revenues from a multifamily apartment property depend on the rental and occupancy rates of the property and on the level of operating expenses. Occupancy rates and rents are directly affected by the supply of, and demand for, apartments in the market area in which a property is located. This, in turn, is affected by several factors such as local or national economic conditions, the amount of new apartment construction and the affordability of single-family homes. In addition, factors such as government regulation (such as zoning laws), inflation, real estate and other taxes, labor problems and natural disasters can affect the economic operations of an apartment property.

 

The VIEs’ primary uses of cash are: (i) the payment of operating expenses; and (ii) the payment of debt service on the VIEs’ bonds and mortgage notes payable which are held by the Partnership.

 

Consolidated Liquidity

 

On a consolidated basis, cash provided by operating activities for 2007 decreased approximately $1.4 million compared to 2006 mainly due to changes in working capital components. Cash from investing activities decreased approximately $54.4 million, in 2007 compared to 2006 primarily due to the purchase of the MF Properties and the acquisition of additional tax-exempt revenue bonds in 2007. Cash from financing activities increased approximately $57.0 million in 2007 compared to 2006. This is the result of the receipt of proceeds from the mortgage on the MF Properties, additional issuances of debt in the P-Float program, and the sale of additional BUCs offset by the payment of liabilities assumed.

 

In connection with the acquisition of the MF Properties, an aggregate loan of approximately $19.9 million was utilized by the underlying limited partnerships to refinance their existing mortgages. The interest rate on this mortgage is variable and is calculated as one month LIBOR plus 1.55%. As of the transaction date, one month LIBOR was 5.32% and the interest on the mortgage was 6.87%. As of December 31, 2007, one month LIBOR was 4.86% and the interest on the mortgage was 6.41%. To mitigate exposure to this variable rate mortgage, an interest rate cap was purchased which effectively caps the interest rate on this mortgage at 8.3%. The mortgage matures in July 2009. In addition, the Company entered into three new P-Float securitization transactions for a total of $25.9 million of new debt. Such securitization transactions through the Merrill Lynch P-Float program are accounted for as secured borrowings and, in effect, provide variable-rate financing for the acquisition of new, or the securitization of existing, tax-exempt mortgage revenue bonds. This debt financing bears interest at a weekly floating bond rate, including associated remarketing, credit enhancement, liquidity and trustee fees. The average interest rates for all debt in the P-Float program was 4.5% per annum and 4.3% per annum during 2007 and 2006, respectively. Maturity dates for the Company’s debt financing range from 2008 through 2038.

Historically, our primary leverage vehicle has been the Merrill Lynch P-Float program. Recent credit losses and credit rating downgrades at Merrill Lynch have resulted in a significant increase in Merrill Lynch’s cost of borrowing under the P-Float program since December 31, 2007. This is reflected in an increased spread over the SIFMA rate payable on the P-Floats. The increased spread over SIFMA has resulted in a significantly higher interest rate on the Partnership’s P-Float financing. As discussed in Item 7A, Quantitative and Qualitative Disclosures about Market Risks, the Partnership’s effective interest rate on its P-Float borrowings has increased approximately 1.25% to 2.0% from November 30, 2007 to February 29, 2008. A 1.5% increase in the Partnership’s effective interest rate, on an annualized basis, would result in approximately $1.1 million of additional interest expense on the Partnership’s existing P-Float financing. This additional interest expense will lower the Partnership’s CAD.

 

In addition, if the interest rate on the P-Floats rise to a level where the interest received on the underlying tax-exempt bonds is not sufficient to pay all interest due on the P-Floats, the P-Float may be terminated and the underlying tax-exempt bonds may be sold in order to satisfy the obligations on the P-Floats. Due to these developments with our P-Float debt, we do not expect to have access to additional debt financing through the Merrill Lynch P-Float program for the foreseeable future and this is expected to limit our ability to acquire additional tax-exempt bonds on a leveraged basis.

 

We are currently evaluating alternative financing vehicles to replace our P-Float debt in order to reduce our interest expense and in order to have access to new leverage financing for additional tax-exempt mortgage bonds on reasonable terms. We have not entered into any agreements with respect to any such alternative debt financing and there can be no assurances that we will be able to do so.

 

In the long-term, the Partnership believes that cash provided by its tax-exempt mortgage revenue bonds and other investments will be adequate to meet its projected liquidity requirements, including the payment of expenses, interest and distributions to BUC holders. Recently, income from investments has not been sufficient to fund such expenditures without utilizing cash reserves to supplement the deficit. Additionally, the increased costs of borrowing described above will further reduce CAD. While the Partnership currently expects to maintain the annual distribution amount of $0.54 per BUC, if we are unable to secure alternative financing and our cost of borrowing remains at the current increased level for an extended period, the annual distribution amount may need to be reduced. See discussion below regarding “Cash Available for Distribution.”

 

Cash Available for Distribution

 

Management utilizes a calculation of Cash Available for Distribution (“CAD”) as a means to determine the Partnership’s ability to make distributions to BUC holders. The General Partner believes that CAD provides relevant information about its operations and is necessary along with net income for understanding its operating results. To calculate CAD, amortization expense related to debt financing costs and bond reissuance costs, Tier 2 income due to the General Partner as defined in the Agreement of Limited Partnership, interest rate cap expense or income, provision for loan losses, impairments on bonds, losses related to VIEs including the cumulative effect of accounting change and depreciation expense are added back to the Company’s net income (loss) as computed in accordance with GAAP. Management evaluates two measures of CAD by further breaking down the calculation into Total CAD and CAD excluding contingent interest. There is no generally accepted methodology for computing CAD, and the Company’s computation of CAD may not be comparable to CAD reported by other companies. Although the Company considers CAD to be a useful measure of its operating performance, CAD should not be considered as an alternative to net income or net cash flows from operating activities which are calculated in accordance with GAAP.

 

The Partnership’s regular annual distributions are currently equal to $0.54 per unit. In recent years CAD excluding contingent interest and realized gains has not been sufficient to fully fund such distributions without utilizing cash reserves to supplement the deficit. During the third quarter of 2007 CAD exceeded the quarterly distribution amount of $0.135 per BUC. During the fourth quarter CAD was approximately $380,000, or $0.03 per BUC, lower than the quarterly distribution amount as a result of the increased borrowing costs associated with our P-Float debt discussed above, the timing of debt borrowings in early fourth quarter, and the reinvestment of the

proceeds in December 2007 and January 2008. While the Partnership currently expects to maintain the annual distribution amount of $0.54 per BUC, if we are unable to secure alternative financing and our cost of borrowing remains at the current increased level for an extended period, the annual distribution amount may need to be reduced.

 

The following tables show the calculation of CAD and the break-down of Total CAD and CAD excluding contingent interest and realized gains for the years ended December 31, 2007, 2006, and 2005.

 

 

 

 

 

Off Balance Sheet Arrangements

 

As of December 31, 2007 and 2006, the Partnership invested in tax-exempt mortgage revenue bonds which are collateralized by multifamily housing projects. The multifamily housing projects are owned by entities that are not controlled by the Partnership. The Partnership has no equity interest in these entities and does not guarantee any obligations of these entities. Some of the ownership entities are deemed to be VIEs and are consolidated with the Partnership for financial reporting purposes. The VIEs that are consolidated with the Partnership do not have off-balance sheet arrangements.

The Partnership has financed the acquisition of some of its tax-exempt revenue bonds using the Merrill Lynch P-Float program. Although this financing involves placing the mortgage revenue bonds in trust in exchange for an interest in the trust, the transaction is treated as a leveraged financing and not a sale of the mortgage revenue bonds. Therefore, the Partnership continues to reflect the mortgage revenue bonds as assets in its balance sheet and does not have any off-balance sheet arrangements.

 

The Partnership does not engage in trading activities involving non-exchange traded contracts. As such, the Partnership is not materially exposed to any financing, liquidity, market, or credit risk that could arise if it had engaged in such relationships.

 

The Partnership does not have any relationships or transactions with persons or entities that derive benefits from their non-independent relationships with the Company or its related parties other than what is disclosed in Note 8 to the Company’s consolidated financial statements.

 

Contractual Obligations

 

The Partnership has the following contractual obligations as of December 31, 2007:

 

 

 

 

Inflation

 

With respect to the financial results of the Partnership’s investments in tax-exempt mortgage revenue bonds, substantially all of the resident leases at the multifamily residential properties, which collateralize the Partnership’s tax-exempt mortgage revenue bonds, allow, at the time of renewal, for adjustments in the rent payable there under, and thus may enable the properties to seek rent increases. The substantial majority of these leases are for one year or less. The short- term nature of these leases generally serves to reduce the risk to the properties of the adverse effects of inflation; however, market conditions may prevent the properties from increasing rental rates in amounts sufficient to offset higher operating expenses. Inflation did not have a significant impact on the Partnership’s financial results for the years presented in this report.

 

Recent Accounting Pronouncements

 

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109. The interpretation clarifies the accounting for uncertainty in tax positions. The interpretation, effective for the Company beginning in the first quarter of 2007, did not have a material effect on the Partnership.

 

In September 2006, the FASB issued Statement No. 157, Fair Value Measurement (“SFAS No. 157”). This statement does not require new fair value measurements, however, it provides guidance on applying fair value and expands required disclosures. SFAS No. 157 is effective beginning in the first quarter of 2008. The Company does not expect the application of SFAS No. 157 to have a material impact on the consolidated financial statements.

 

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB No. 115 (“SFAS No. 159”). This statement permits, but does not require, entities to choose to measure many financial instruments and certain other items as fair value.

SFAS No. 159 is effective for us beginning in the first quarter of 2008. The Company has evaluated the provisions of SFAS No. 159 and did not elect to adopt the fair value option on any financial instruments held by the Company on December 31, 2007. Management has not determined whether it will elect this option for any new financial instruments acquired in the future.

 

In June 2007, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 07-1, Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting for Parent Companies and Equity Method Investors for Investments in Investment Companies. This SOP provides guidance for determining whether an entity is within the scope of the AICPA Audit and Accounting Guide Investment Companies (the “Guide”). Entities that are within the scope of the Guide are required, among other things, to carry their investments at fair value, with changes in fair value included in earnings. In October 2007, the effective date of this SOP was deferred indefinitely. The Company is currently evaluating this new guidance and has not determined whether it will be required to apply the provisions of the Guide in presenting its financial statements.

 

In December 2007, the FASB issued Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements- an amendment of ARB 51 (“SFAS No. 160”). SFAS No. 160 requires that a noncontrolling interest in a subsidiary be reported as equity and the amount of consolidated net income specifically attributable to the noncontrolling interest be identified in the consolidated financial statements. It also calls for consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any noncontrolling equity investment retained in a deconsolidation. SFAS No. 160 is effective for the Company on January 1, 2009. The Company is currently evaluating the impact that SFAS No. 160 will have on its consolidated financial statements upon adoption.

 

In December 2007, the FASB issued Statement No. 141 (revised 2007), Business Combinations (“SFAS No. 141R”). SFAS No. 141R broadens the guidance of SFAS No. 141, extending its applicability to all transactions and other events in which one entity obtains control over one or more other businesses. It broadens the fair value measurement and recognition of assets acquired, liabilities assumed, and interests transferred as a result of business combinations. SFAS No. 141R is effective for the Company on January 1, 2009. The Company is currently evaluating the impact that SFAS No. 141R will have on its consolidated financial statements upon adoption.

 

 

The Partnership’s primary market risk exposures are interest rate risk and credit risk. The Partnership’s exposure to market risks relates primarily to its investments in tax-exempt mortgage revenue bonds and its debt financing.

 

The Company bases the fair value of the tax-exempt bonds, which have a limited market, on quotes from external sources, such as brokers, for these or similar bonds. In the limited situation when quotes are unavailable, the Company estimates the fair value for each bond as the present value of its expected cash flows using a discount rate for comparable tax-exempt investments. This calculation methodology encompasses judgment in its application. As of December 31, 2007, approximately $60 million of the Company’s tax-exempt mortgage revenue bonds are valued using broker quotes and approximately $5.7 million are valued using management’s discounted cash flow analyses. Broker quotes and management’s discounted cash flow analyses provide indicative pricing only. Due to the limited market for the tax-exempt bonds, these estimates of fair value do not necessarily represent what the Company would actually receive in a sale of the bonds.

 

The credit and capital markets have continued to deteriorate. If uncertainties in these markets continue, the markets deteriorate further or the Company experiences deterioration in the values of its investment portfolio, the Company may incur impairments to its investment portfolio which could negatively impact the Company’s financial condition, cash flows, and reported earnings.

 

Interest Rate Risk

 

Interest rates are highly sensitive to many factors, including governmental, monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Partnership’s

control. The nature of the Partnership’s investment in the tax-exempt mortgage revenue bonds and the debt financing used to finance these investments exposes the Partnership to financial risk due to fluctuations in market interest rates. The tax-exempt mortgage revenue bonds bear base interest at fixed rates and may additionally pay contingent interest which fluctuates based upon the cash flows of the underlying property. As of December 31, 2007, the weighted average base rate of the tax-exempt mortgage revenue bonds was 6.5%. Accordingly, the interest income generated by the tax-exempt mortgage revenue bonds is generally fixed, except to the extent the underlying properties generate enough excess cash flow to pay contingent interest. Each of the bonds matures after 2011.

 

Conversely, the interest rates on the Partnership’s floating rate debt financing fluctuate based on the SIFMA Index Rate, which resets weekly. Accordingly, the Partnership’s cost of borrowing will increase as the SIFMA Index Rate increases. As of December 31, 2007, the Partnership had total debt financing outstanding of $71.4 million. The weighted average effective interest rate for 2007 on the debt outstanding as of December 31, 2007 was approximately 4.5%. If the average SIFMA Index Rate, including fees, had increased or decreased by 100 basis points for the year ended December 31, 2007, the interest expense payments on this variable-rate debt financing would have increased or decreased by approximately $714,000, respectively. If the SIFMA Index Rate were to increase 100 basis points, certain interest rate cap agreements, described below, would be exceeded, thereby reducing the impact of the interest rate increase by approximately $300,000.

 

In the event of a significant unfavorable fluctuation in interest rates, the Partnership may collapse each of its financing transactions by exercising the call feature of the respective bond securitization. The SIFMA Index Rate, net of any fees, ranged from 3.09% to 3.95% during the year ended December 31, 2007, while the base rates of the securitized tax-exempt mortgage revenue bonds range from 6.15% to 7.50% as of December 31, 2007. In the event that the SIFMA Index Rate rises dramatically and exceeds the base rate of the securitized tax-exempt mortgage revenue bonds, the trust holding the bonds would be collapsed as a result of insufficient interest from the underlying fixed-rate tax-exempt mortgage bond to service the floating rate senior interest obligations of the P-Float. Upon collapse of the trust, the Company would have to either refinance or sell the tax-exempt mortgage revenue bonds. A decrease in the net interest income earned through the structure of the securitizations would decrease cash available for distributions.

 

Historically, our primary leverage vehicle has been the Merrill Lynch P-Float program. Recent credit losses and credit rating downgrades at Merrill Lynch have resulted in a significant increase in Merrill Lynch’s cost of borrowing under the P-Float program. This is reflected in an increased spread over the SIFMA rate payable on the P-Floats. The increased spread over SIFMA has resulted in a significantly higher interest rate on the Partnership’s P-Float financing.

 

The following table displays the SIFMA rate, estimated P-Float program credit spread and the resulting effective interest rate to the Partnership under the P-Float program as of the dates shown.

 

 

The increased P-Float program credit spread has resulted in a significantly higher effective interest rate for the Partnership. As shown in the table above, the Partnership’s effective interest rate has increased approximately 1.25% to 2.0% from November 30, 2007 to February 29, 2008. A 1.5% increase in the Partnership’s effective interest rate, on an annualized basis, would result in approximately $1.1 million of additional interest expense based on $71.4 million of outstanding P-Float debt. We are currently evaluating alternative financing vehicles to replace our P-Float debt in order to reduce our interest expense and in order to have access to new leverage financing for additional tax-exempt mortgage bonds on reasonable terms. We have not entered into any agreements with respect to any such alternative debt financing and there can be no assurances that we will be able to do so. Additionally,

there can be no assurances that our existing P-Float debt will remain in place even with the additional costs currently being incurred.

 

The interest rate of the mortgage financing on the MF Properties fluctuates based on the LIBOR. Accordingly, the cost of borrowing on the debt will increase as the LIBOR increases. As of December 31, 2007, the outstanding balance of the mortgage financing of the MF Properties was $19.9 million. The weighted average effective interest rate for 2007 on the debt outstanding as of December 31, 2007 was approximately 7.0%. If the average LIBOR Rate, including fees, had increased or decreased by 100 basis points for the year ended December 31, 2007, the interest expense payments on this variable-rate debt financing would have increased or decreased by approximately $199,000, respectively.

 

The Partnership is managing its interest rate risk on its debt financing by entering into interest rate cap agreements that cap the amount of interest expense it could pay on its floating rate debt financing as follows:

 

 

 

 

Using the cap agreements, the Partnership is able to benefit from a low interest rate environment, while still remaining protected from a significant increase in the floating rates. This rate is set weekly and settlements under the swap agreement will be made monthly based on the original notional amount of $15,000,000. The swap will maintain the original expiration date of January 1, 2010.

 

The cap agreements are required to be marked to fair value with the difference recognized in earnings as interest expense which can result in significant volatility to reported net income over the term of the caps. The weighted-average effective rate on the debt financing, excluding the effect of marking the interest rate cap agreements to fair value, was 4.5% for the year ended December 31, 2007. At times during 2007, our effective interest rates were in excess of our interest rate caps resulting in cash payments to the Partnership of approximately $76,000.

 

The fair value of the Partnership’s investments in tax-exempt mortgage revenue bonds, which bear fixed base interest rates, is also directly impacted by changes in market interest rates. An increase in rates will cause the fair value of the bonds to decrease. Although changes in the fair value of the bonds does not impact earnings or cash flow, they affect total partners’ capital and book value per unit. In addition, if the fair value of the bonds decreases, the Partnership may need to provide additional collateral for its debt financing.

 

Credit Risk

 

The Partnership’s primary credit risk is the risk of default on its portfolio of tax-exempt mortgage revenue bonds and taxable loans collateralized by the multifamily properties. The tax-exempt mortgage revenue bonds are not direct obligations of the governmental authorities that issued the bonds and are not guaranteed by such authorities or any insurer or other party. In addition, the tax-exempt mortgage revenue bonds and the associated taxable loans are non-recourse obligations of the property owner. As a result, the sole source of principal and interest payments (including both base and contingent interest) on the tax-exempt mortgage revenue bonds and the taxable loans is the net rental revenues generated by these properties or the net proceeds from the sale of these properties.

 

If a property is unable to sustain net rental revenues at a level necessary to pay current debt service obligations on the Partnership’s tax-exempt mortgage revenue bond or taxable loan on such property, a default may occur. A property’s ability to generate net rental income is subject to a wide variety of factors, including rental and occupancy rates of the property and the level of operating expenses. Occupancy rates and rents are directly affected by the supply

of, and demand for, apartments in the market area in which a property is located. This, in turn, is affected by several factors such as local or national economic conditions, the amount of new apartment construction and the affordability of single-family homes. In addition, factors such as government regulation (such as zoning laws), inflation, real estate and other taxes, labor problems and natural disasters can affect the economic operations of an apartment property.

 

Additionally, four bonds owned by the Partnership are construction bonds. The principal risk associated with construction lending is the risk that construction of the property will be substantially delayed or never completed. This may occur for a number of reasons including (i) insufficient financing to complete the project due to underestimated construction costs or cost overruns; (ii) failure of contractors or subcontractors to perform under their agreements, (iii) inability to obtain governmental approvals; (iv) labor disputes, and (v) adverse weather and other unpredictable contingencies beyond the control of the developer. If a property is not completed, or costs more to complete than anticipated, it may cause the Partnership to receive less than the full amount of interest owed to it on the tax-exempt bond financing such property or otherwise result in a default under the mortgage loan that secures its tax-exempt bond on the property. As construction or renovation is completed, these properties will move into the lease-up phase. The lease-up of these properties may not be completed on schedule or at anticipated rent levels, resulting in a greater risk that these investments may go into default than investments secured by mortgages on properties that are stabilized or fully leased-up. The underlying property may not achieve expected occupancy or debt service coverage levels. In order to lower these risks, the Partnership has required the owners/developers of these projects to enter into guaranteed maximum price contracts, obtain payment and performance bonds, and have capitalized interest reserve funds.

 

Defaults on its tax-exempt mortgage revenue bonds and taxable loans may reduce the amount of future cash available for distribution to BUC holders. In addition, if a property’s net rental income declines, it may affect the market value of the property. If the market value of a property deteriorates, the amount of net proceeds from the ultimate sale or refinancing of the property may be insufficient to repay the entire principal balance of the tax-exempt mortgage revenue bond or taxable loan secured by the property.

 

In the event of a default on a tax-exempt mortgage revenue bond or taxable loan, the Partnership will have the right to foreclose on the mortgage or deed of trust securing the property. If the Partnership takes ownership of the property securing a defaulted tax-exempt mortgage revenue bond, it will be entitled to all net rental revenues generated by the property. However, such amounts will no longer represent tax-exempt interest to the Partnership.

 

The Partnership’s primary method of managing the credit risks associated with its tax-exempt mortgage revenue bonds and taxable loans is to perform a complete due diligence and underwriting process of the properties securing these mortgage bonds and loans and to carefully monitor the performance of such property on a continuous basis.

 

The Partnership is also exposed to credit risk with respect to its debt financing. A significant portion of the Partnership’s debt financing has been obtained using securitizations issued through the Merrill Lynch P-Float program. In this program, the senior interests sold are credit enhanced by Merrill Lynch or its affiliate. The inability of Merrill Lynch or its affiliate to perform under the program or impairment of the credit enhancement may increase the cost of borrowing under the P-Float program or may even terminate the transaction and cause the Partnership to lose the net interest income earned as a result. The Partnership recognizes the concentration of financing with this institution and periodically monitors its ability to continue to perform.

 

As the above information incorporates only those material positions or exposures that existed as of December 31, 2007, it does not consider those exposures or positions that could arise after that date. The ultimate economic impact of these market risks on the Partnership will depend on the exposures that arise during the period, the Partnership’s risk mitigating strategies at that time and overall business and economic environment.

 

Concentration of Credit Risk

 

The Company maintains the majority of its unrestricted cash balances at two financial institutions. The balances are insured by the Federal Deposit Insurance Corporation up to $100,000 at each institution. At various times, the cash balances may exceed the $100,000 limit. The Company is also exposed to risk on its short-term investments in the event of non-performance by counterparties. The Company does not anticipate any non-performance. This risk is minimized significantly by the Company’s portfolio being restricted to investment grade securities.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Partners of

America First Tax Exempt Investors, L.P.

Omaha, Nebraska

 

We have audited the accompanying consolidated balance sheets of America First Tax Exempt Investors, L.P. and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, of partners’ capital and comprehensive income (loss), and of cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Woodbridge Apartments of Louisville II, L.P. and Woodbridge Apartments of Bloomington III, L.P. (consolidated variable interest entities), which statements, collectively, reflect total assets constituting 8% of consolidated total assets as of December 31, 2006, and total revenues constituting 21% and 17% of consolidated total revenues for the years ended December 31, 2006 and 2005, respectively. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Woodbridge Apartments of Louisville II, L.P. and Woodbridge Apartments of Bloomington III, L.P., is based solely on the reports of the other auditors.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. 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 and the reports of the other auditors provide a reasonable basis for our opinion.

 

In our opinion, based on our audits and the reports of the other auditors, such consolidated financial statements present fairly, in all material respects, the financial position of America First Tax Exempt Investors, L.P. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 4 to the financial statements, the financial statements include tax-exempt investments valued at $66,167,000 (40% of total assets) and $27,103,000 (27% of total assets) as of December 31, 2007 and 2006, respectively, whose fair values have been estimated by management in the absence of readily determinable fair values. Management’s estimates are based on quotes from external sources, such as brokers, for these or similar investments. In the limited situation when quotes are unavailable, management estimates the fair value of each investment as the present value of the expected cash flows using a discount rate for comparable tax-exempt investments.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 11, 2008 expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

 

Omaha, Nebraska

March 11, 2008

AMERICA FIRST TAX EXEMPT INVESTORS, L.P.

 

CONSOLIDATED BALANCE SHEETS