EMERALD COAST HOUSING II, INC. ECH II CAPTAINS QUARTERS, LLC PROJECT. Financial Statements and Supplemental Information. September 30, 2012 and 2011

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1 EMERALD COAST HOUSING II, INC. ECH II CAPTAINS QUARTERS, LLC PROJECT Financial Statements and Supplemental Information

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3 EMERALD COAST HOUSING II, INC. ECH II CAPTAINS QUARTERS, LLC PROJECT Financial Statements and Supplemental Information TABLE OF CONTENTS INDEPENDENT AUDITOR'S REPORT 1 INDEPENDENT AUDITOR'S REPORT ON COMPLIANCE WITH TRUST INDENTURE PROVISIONS BASED ON OUR AUDIT OF THE FINANCIAL STATEMENTS 2 FINANCIAL STATEMENTS Balance Sheets 3 Statements of Income 4 Statements of Cash Flows 5 Notes to Financial Statements 6 INDEPENDENT AUDITOR'S REPORT ON SUPPLEMENTAL INFORMATION 13 SUPPLEMENTAL INFORMATION Schedule of Revenues and Certain Expenses - Budget to Actual 14 Notes to Schedule of Revenues and Certain Expenses - Budget to Actual 15 Page

4 45 Eglin Pkwy., N.E. Suite 301 Fort Walton Beach, FL Fax: To the Board of Directors and Management of Emerald Coast Housing II, Inc., the Fort Walton Beach, Florida INDEPENDENT AUDITOR'S REPORT We have audited the accompanying balance sheets of the (the Project), a component of Emerald Coast Housing II, Inc., as of September 30, 2012, and 2011, and the related statements of income and statements of cash flows for the years then ended. These financial statements are the responsibility of the Project's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Project's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Project as of September 30, 2012, and 2011, and the results of its operations and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. We have also issued a report dated January 31, 2013, on our consideration of the Project's compliance with Trust Indenture provisions based on our audits of the financial statements. January 31,

5 45 Eglin Pkwy., N.E. Suite 301 Fort Walton Beach, FL Fax: To the Board of Directors and Management of Emerald Coast Housing II, Inc., the and Bank of Oklahoma, N.A. Fort Walton Beach, Florida INDEPENDENT AUDITOR'S REPORT ON COMPLIANCE WITH TRUST INDENTURE PROVISIONS BASED ON OUR AUDIT OF THE FINANCIAL STATEMENTS We have audited, in accordance with auditing standards generally accepted in the United States of America, the balance sheets of the (the Project), a component of Emerald Coast Housing II, Inc., as of September 30, 2012, and 2011, and the related statements of income and statements of cash flows for the years then ended, and have issued our report thereon dated January 31, In connection with our audits, except as noted below, nothing came to our attention that caused us to believe that the Project, for the years ended September 30, 2012, and 2011, failed to comply with any of the terms, covenants, provisions, or conditions of Section 10 the Trust Indenture dated December 1, 2007, with Bank of Oklahoma, N.A., insofar as they relate to accounting matters. However, our audits were not directed primarily toward obtaining knowledge of such noncompliance. The Project did not meet the rate coverage requirement in Section 5.7 of the Trust Indenture for the year ended September 30, As of September 30, 2012, the Project has not fully paid its real estate taxes as required by Section 5.7 of the Trust Indenture. The Trustee has acknowledged the noncompliance matters addressed above and has issued a written covenant waiver. This report is intended solely for the information and use of the Board of Directors and Management of Emerald Coast Housing II, Inc., the, and the Bank of Oklahoma, N.A. and should not be used for any other purpose. January 31,

6 BALANCE SHEETS ASSETS CURRENT ASSETS Cash and cash equivalents Operating cash $ 72,053 $ 74,983 Restricted for bond repayment fund 290, ,993 Receivables Rent, net 5,868 13,702 Prepaid expense 31,466 30,762 Total current assets 400, ,440 PROPERTY AND EQUIPMENT, NET 8,262,537 8,609,388 OTHER ASSETS Restricted cash Bond reserve fund 933, ,235 Security deposits 129, ,897 Bond issuance costs, net of amortization 955, ,494 Total other assets 2,017,569 2,045,626 TOTAL ASSETS $ 10,680,185 $ 11,107,454 LIABILITIES AND ACCUMULATED DEFICIT CURRENT LIABILITIES Trade accounts payable $ 55,238 $ 14,243 Accrued expenses 475, ,752 Accrued interest payable 430, ,449 Deferred income 8,787 5,121 Security deposits 129, ,197 Bonds payable 165, ,000 Total current liabilities 1,264,574 1,185,762 LONG-TERM LIABILITIES Bonds payable, net of current portion 11,246,250 11,411,250 TOTAL LIABILITIES 12,510,824 12,597,012 ACCUMULATED DEFICIT (1,830,639) (1,489,558) TOTAL LIABILITIES AND ACCUMULATED DEFICIT $ 10,680,185 $ 11,107,454 The accompanying notes are an integral part of these financial statements. 3

7 STATEMENTS OF INCOME Years Ended REVENUES Rent $ 1,823,136 $ 1,831,470 Interest income 1,102 1,018 Other revenue 21,675 40,817 Total revenues 1,845,913 1,873,305 EXPENSES Administrative and general 69, ,169 Management fees 108, ,456 Maintenance and repairs 102,326 88,179 Replacements 26,239 43,009 Payroll reimbursement 221, ,116 Taxes and insurance 283, ,159 Utilities 186, ,554 Interest 804, ,399 Total expenses before depreciation and amortization 1,801,932 1,825,041 Earnings (loss) before depreciation and amortization 43,981 48,264 Depreciation 346, ,851 Amortization 38,211 38,211 NET LOSS (341,081) (336,798) ACCUMULATED DEFICIT - BEGINNING OF YEAR (1,489,558) (1,152,760) ACCUMULATED DEFICIT - END OF YEAR $ (1,830,639) $ (1,489,558) The accompanying notes are an integral part of these financial statements. 4

8 STATEMENTS OF CASH FLOWS Years Ended CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (341,081) $ (336,798) Adjustments to reconcile net loss to net cash flows from operating activities Depreciation 346, ,851 Amortization 38,211 38,211 (Increase) decrease in Rent receivable 7,834 14,538 Prepaid expense (704) (2,504) Security deposits (10,239) (30,924) Increase (decrease) in Trade accounts payable 40,995 (29,883) Accrued expenses (19,906) 9,619 Accrued interest payable 33,118 33,319 Deferred income 3,666 (8,842) Security deposits 10,939 30,224 Net cash flows from operating activities 109,684 63,811 CASH FLOWS FROM FINANCING ACTIVITIES Transfer from (to) bond repayment fund 42, ,003 Transfer from (to) bond fund reserves 85 - Payments on bonds (155,000) (145,000) Net cash flows from financing activities (112,614) (28,997) NET CHANGE IN CASH (2,930) 34,814 CASH - BEGINNING OF YEAR 74,983 40,169 CASH - END OF YEAR $ 72,053 $ 74,983 SUPPLEMENTAL DISCLOSURES Interest paid $ 771,180 $ 780,180 The accompanying notes are an integral part of these financial statements. 5

9 NOTES TO FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. Nature of Organization Emerald Coast Housing II, Inc. (the Corporation) was formed on April 16, 1992, under the Florida Not-for-Profit Corporation Act, as amended. The Corporation was formed to provide housing for persons of low and moderate means and to promote neighborhood and community redevelopment within Okaloosa County, Florida. The Corporation consists of two projects, the Royale Project and the ECH II Captains Quarters, LLC Project. Both projects have issued tax-exempt revenue bonds. The individual project's bond trust indenture requires separate audited financial statements for each project. Accordingly, these financial statements do not include any assets, liabilities, net assets, revenues and expenses, or commitments and contingencies of the other project or the Corporation itself. The (the Project) was acquired on December 26, 2007, with proceeds from a tax-exempt revenue bond issue sponsored by the Town of Shalimar, Florida. The Project consists of 16 properties with 355 apartment units in Okaloosa County, Florida. B. Basis of Accounting The financial statements have been prepared for the Project owned by Emerald Coast Housing II, Inc. The financial statements are prepared on the accrual basis of accounting. Rent revenue is initially recognized each month based on full occupancy (gross potential rent) and presented net of rent concessions for special lease incentives, bad debts, vacancies, and rent adjustments for the income level of the individual occupying the unit. Other types of income are recognized when earned. Expenses are recognized as incurred. C. Cash and Cash Equivalents For purposes of the Statements of Cash Flows, the Project considers all highly liquid investments available for use, with an original maturity of three months or less, to be cash equivalents. D. Restricted Cash Certain proceeds of the housing revenue bonds, as well as certain resources set aside for their repayment, are classified as restricted on the Statements of Financial Position because their use is limited by applicable bond covenants. These proceeds are deposited into a separate trust cash account. Section 5.01 of the Trust Indenture established a Bond Reserve Fund in the amount of $933,235. As of September 30, 2012, and 2011, the Bond Reserve Fund was underfunded by $85 and $0, respectively. 6

10 NOTES TO FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. Restricted Cash (Continued) Additionally, security deposits received from tenants are placed in a separate bank account. This money is restricted to be used for either payment of the final monthly rent, damages, or returned to the tenant upon final inspection. E. Rents Receivable Rents receivable are carried at original assessment less an estimated amount for doubtful accounts based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by identifying troubled accounts and by using historical experience applied to an aging of accounts. Rents receivable are written off when deemed uncollectible. Recoveries of such receivables previously written off are recorded when received. An account is considered past due when the balance of the receivable is outstanding for more than 30 days. A $65 late fee is assessed after five days past due, with no additional late fees or interest assessed thereafter. After 60 days, accounts are written off and charged to operations and suspended from future activity, unless recovery is made. Management estimates that approximately $0, and $966 of its accounts receivable is uncollectible as of September 30, 2012, and 2011, respectively. F. Property and Equipment Property and equipment are recorded at cost. Depreciation on buildings and improvements is computed on the straight-line basis over the asset's estimated useful life. The estimated useful lives of the respective assets range from seven to forty years. G. Bond Issuance Costs Bond issuance costs are amortized over the term of the bonds using the straight-line method since the difference between this and the effective interest method is not material to the financial statements. Accumulated amortization at September 30, 2012, and 2011, is $191,056 and $152,845, respectively. H. Income Taxes The Project has been granted an exemption from income taxes under Internal Revenue Code, Section 501(c)(3) as a not-for-profit corporation. Management is not aware of any uncertain tax positions that would require disclosure or accrual in accordance with generally accepted accounting principles. With few exceptions, the Project is no longer subject to federal, state or local income tax examination by tax authorities for years before

11 NOTES TO FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) I. Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. J. Subsequent Events The Project has evaluated events and transactions that occurred between September 30, 2012, and January 31, 2013, which is the date the financial statements were available to be issued, for possible recognition or disclosure in the financial statements. NOTE 2 - PROPERTY AND EQUIPMENT Major classifications of property and equipment are summarized as follows: Land $ 1,982,013 $ 1,982,013 Buildings 7,432,574 7,432,574 Furniture and fixtures 495, ,492 9,910,079 9,910,079 Less accumulated depreciation (1,647,542) (1,300,691) $ 8,262,537 $ 8,609,388 NOTE 3 - ACCRUED EXPENSES At September 30, 2012, and 2011, accrued expenses consisted of the following: Property taxes $ 254,415 $ 314,992 Management fees 221, ,760 $ 475,846 $ 495,752 NOTE 4 - ACCRUED INTEREST PAYABLE At September 30, 2012, and 2011, accrued interest payable consists of the following: Series 2007A (Senior) Housing Revenue Bonds $ 255,510 $ 258,610 Series 2007B (Subordinate) Housing Revenue Bonds 175, ,839 $ 430,567 $ 397,449 8

12 NOTES TO FINANCIAL STATEMENTS NOTE 4 - ACCRUED INTEREST PAYABLE (CONTINUED) At September 30, 2012, $162,984 of the 2007B (Subordinate) Bond interest is past due. Bond interest payments are due semi-annually on June 1, and December 1, of each year. NOTE 5 - BONDS PAYABLE Housing Revenue Bonds $11,655,000 Housing Revenue Bonds, Series 2007A (Senior), due in varying annual installments beginning December 1, 2008, through December 1, 2037; interest ranging from 6.0% to 7.0% per annum. Interest payments due semi-annually, June 1 and December 1, beginning June 1, 2008, through December 1, $ 11,030,000 $ 11,185,000 $381,250 Housing Revenue Bonds, Series 2007B (Subordinate), is due at the maturity date of December 1, 2037; interest at 9.5% per annum. Interest payments due semi-annually, June 1 and December 1, beginning June 1, 2008, through December 1, , ,250 Total bonds payable 11,411,250 11,566,250 Less current portion (165,000) (155,000) Bonds payable $ 11,246,250 $ 11,411,250 Future maturities of the housing revenue bonds are as follows: Series 2007A Series 2007B Total December 1, 2012 $ 165,000 $ - $ 165,000 December 1, , ,000 December 1, , ,000 December 1, , ,000 December 1, , ,000 Thereafter 10,095, ,250 10,476,250 NOTE 6 - FINANCIAL BOND COVENANTS $ 11,030,000 $ 381,250 $ 11,411,250 The bond indenture contains financial covenants that require the following: The Project shall fix the rental rates, less budgeted operating expenses, to equal at least 115% of the amount necessary to pay principal and interest due in such year on the Series A Senior Bonds. Annual audited financial statements are to be filed with the Trustee within 120 days after the end of the fiscal year of the Project. 9

13 NOTES TO FINANCIAL STATEMENTS NOTE 6 - FINANCIAL BOND COVENANTS (CONTINUED) Annual budgets are to be filed to the Trustee and certain major bondholders no less than 45 days before the end of the previous fiscal year. The Project shall pay from revenues all real estate taxes and assessments or other municipal or governmental charges. The Project must maintain insurance policies that cover full replacement value of the Project. Management is aware of two violations of the financial covenants at September 30, 2012, which consists of failure to maintain the rate covenant, as computed below, and failure to pay all real estate taxes. Non-compliance with these and other requirements may constitute an Event of Default under Section 7.01 of the Trust Indenture. As such, the bonds are considered in default due to the items noted above. However, the Trustee has acknowledged the noncompliance matters addressed above and has issued a written covenant waiver associated with those matters. As of the date of this report, no event of default has been issued by the Trustee. 10

14 NOTES TO FINANCIAL STATEMENTS NOTE 6 - FINANCIAL BOND COVENANTS (CONTINUED) Rate covenant provision is calculated as follows: Rent, net $ 1,823,136 $ 1,831,470 Interest income 1,102 1,018 Other income 21,675 40,817 Total revenue, income and other receipts of the Project 1,845,913 1,873,305 Less budgeted expenses* Management fees (50%) 54,230 54,230 Operating expenses Maintenance and repairs 110, ,050 Utilities 175, ,000 Administrative and general 85,930 85,930 Taxes and insurance 360, ,132 Payroll reimbursement 187, ,856 Total budgeted expenses 973, ,198 Adjusted revenues and income of the Project $ 872,715 $ 900,107 Senior bond interest payments $ 771,180 $ 780,180 Senior bond principal payments 155, ,000 Total Senior bond debt service $ 926,180 $ 925,180 Rate coverage 94 % 97 % Rate coverage requirement 115 % 115 % *The Trust Indenture requires consideration of amounts necessary to meet the management fee, taxes, and insurance premiums and other additional operating expenses, based on amounts assigned by the budget of the Project and not actual expenses. NOTE 7 - RELATED PARTY TRANSACTIONS General The Project operates under a 5-year contract dated May 19, 2010, with Progressive Management of America, Inc. to provide all management services for apartments owned by Emerald Coast Housing II, Inc. Monthly management fees for 2012 were $4,519 fixed portion, with an additional $4,519 subordinate to bond interest and principal payments. Management fees for the years ended September 30, 2012, and 2011, were $108,456. Unpaid management fees at September 30, 2012, and 2011, were $221,431 and $180,760, respectively. 11

15 NOTES TO FINANCIAL STATEMENTS NOTE 7 - RELATED PARTY TRANSACTIONS (CONTINUED) General (Continued) In addition, the management company provided the following services during the years ended September 30, 2012, and 2011: Item Basis for Charge Maintenance labor Cost of maintenance labor. $ 96,200 $ 90,180 Administrative labor Cost of administrative labor. 80,529 74,565 Other indirect payroll Cost of actual payroll taxes and benefits. 44,755 34,371 $ 221,484 $ 199,116 The above charges for labor were in compliance with Article V of the management agreement. Other reimbursable expenses charged to the Project by Progressive Management of America, Inc. include allocations for software and accounting personnel compensation. The total of these reimbursable expenses for the years ended September 30, 2012, and 2011, were $7,626 and $7,518, respectively. These costs are included as part of general and administrative expenses. NOTE 8 - CONCENTRATIONS The Project maintains balances for certain bank and trust accounts which are not insured by the Federal Deposit Insurance Corporation (FDIC). At September 30, 2012, and 2011, the uninsured balances are $77,499 and $116,051, respectively, which is the Project's exposure to loss. The trust accounts include all non-operating reserve funds. NOTE 9 - COMMITMENTS AND CONTINGENCIES Real Estate Taxes Subsequent to year-end, the Project has made payments of $39,152 relating to outstanding 2011 property taxes. 12

16 45 Eglin Pkwy., N.E. Suite 301 Fort Walton Beach, FL Fax: To the Board of Directors and Management of Emerald Coast Housing II, Inc., the Fort Walton Beach, Florida INDEPENDENT AUDITOR'S REPORT ON SUPPLEMENTAL INFORMATION We have audited the financial statements of the ECH II Captains Quarters, LLC (the Project) as of and for the years ended September 30, 2012, and 2011, and our report thereon dated January 31, 2013, which expressed an unqualified opinion on those financial statements, appears on page 1. Our audit was conducted for the purpose of forming an opinion on the financial statements as a whole. The accompanying Schedule of Revenues and Certain Expenses - Budget to Actual is presented for purposes of additional analysis and is not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information, except for the portion marked "unaudited," on which we express no opinion, has been subjected to the auditing procedures applied in the audits of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the financial statements as a whole. January 31,

17 SUPPLEMENTAL INFORMATION

18 SCHEDULE OF REVENUES AND CERTAIN EXPENSES - BUDGET TO ACTUAL Year Ended September 30, 2012 Budget (Unaudited) Actual Variance REVENUES Rent, net $ 2,169,203 $ 1,823,136 $ (346,067) Interest income 46,962 1,102 (45,860) Other income 118,000 21,675 (96,325) Total revenues 2,334,165 1,845,913 (488,252) OPERATING EXPENSES Management fees (50%) 54,228 54,228 - Operating expenses Maintenance and repairs 110, ,326 7,724 Utilities 175, ,322 (11,322) Administrative and general 85,930 55,690 30,240 Taxes and insurance 360, ,040 77,092 Payroll reimbursement 187, ,484 (33,628) Total operating expenses 973, ,090 70,106 OTHER EXPENSES Debt service - A bonds Interest 647, ,080 (120,105) Principal 258, , ,472 Debt service - B bonds Interest - 36,219 (36,219) Replacements 106,500 26,239 80,261 Management fee (50%) 54,228 54,228 - Bond administration 14,070 14,076 (6) Total other expenses 1,081,245 1,053,842 27,403 SURPLUS (DEFICIT) AFTER DEBT SERVICE $ 279,724 $ (111,019) $ (390,743) See independent auditor's report. The accompanying notes are an integral part of this schedule. 14

19 NOTES TO SCHEDULE OF REVENUES AND CERTAIN EXPENSES - BUDGET TO ACTUAL Year Ended September 30, 2012 NOTE A - BASIS OF PRESENTATION The accompanying Schedule of Revenues and Certain Expenses - Budget to Actual includes budget to actual comparison for the year ended September 30, The budget is presented based on projected cash flows of the Project. The actual figures are presented based on the accrual basis method of accounting. Therefore, some amounts presented in this schedule will differ from amounts presented in the basic financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America. NOTE B - RECONCILIATION TO FINANCIAL STATEMENT NET LOSS Surplus (Deficit) After Debt Service $ (111,019) Depreciation (346,851) Amortization (38,211) Cash payments of principal 155,000 Statement of Income - net loss $ (341,081) 15