10-Q 1 jun_2004-10q.txt AIM 85 JUNE 30 2004 10Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended June 30, 2004 ------------- Commission file number 1-11059 ------------- AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. ----------------------------------------------------- (Exact name of registrant as specified in charter) California 13-3257662 -------------------------------- ----------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 11200 Rockville Pike, Rockville, Maryland 20852 ------------------------------------------ ---------------------------- (Address of principal executive offices) (Zip Code) (301) 816-2300 ---------------------------------------------------- (Registrant's telephone number, including area code) 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 and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of June 30, 2004, 12,079,514 depositary units of limited partnership interest were outstanding. 2 AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. INDEX TO FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2004

3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. BALANCE SHEETS

The accompanying notes are an integral part of these financial statements. 4 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited)

The accompanying notes are an integral part of these financial statements. 5 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. STATEMENT OF CHANGES IN PARTNERS' EQUITY For the six months ended June 30, 2004 (Unaudited)

The accompanying notes are an integral part of these financial statements. 6 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. STATEMENTS OF CASH FLOWS (Unaudited)

The accompanying notes are an integral part of these financial statements. 7 AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. NOTES TO FINANCIAL STATEMENTS (Unaudited) 1. ORGANIZATION American Insured Mortgage Investors - Series 85, L.P. (the "Partnership") was formed pursuant to a limited partnership agreement, as amended, ("Partnership Agreement") under the Uniform Limited Partnership Act of the state of California on June 26, 1984. During the period from March 8, 1985 (the initial closing date of the Partnership's public offering) through January 27, 1986 (the termination date of the offering), the Partnership, pursuant to its public offering of 12,079,389 Depository Units of limited partnership interest ("Units") raised a total of $241,587,780 in gross proceeds. In addition, the initial limited partner contributed $2,500 to the capital of the Partnership in exchange for 125 units of limited partnership interest. CRIIMI, Inc., a wholly-owned subsidiary of CRIIMI MAE Inc. ("CRIIMI MAE"), acts as the General Partner (the "General Partner") for the Partnership and holds a partnership interest of 3.9%. The General Partner provides management and administrative services on behalf of the Partnership. AIM Acquisition Partners L.P. serves as the advisor (the "Advisor") to the Partnership. The general partner of the Advisor is AIM Acquisition Corporation ("AIM Acquisition") and the limited partners include, but are not limited to, The Goldman Sachs Group, L.P., Sun America Investments, Inc. (successor to Broad, Inc.) and CRI/AIM Investment, L.P., a subsidiary of CRIIMI MAE, over which CRIIMI MAE exercises 100% voting control. AIM Acquisition is a Delaware corporation that is primarily owned by Sun America Investments, Inc. and The Goldman Sachs Group, L.P. Pursuant to the terms of certain origination and acquisition services, management services and disposition services agreements between the Advisor and the Partnership (collectively the "Advisory Agreements"), the Advisor renders services to the Partnership, including but not limited to, the management of the Partnership's portfolio of mortgages and the disposition of the Partnership's mortgages. Such services are subject to the review and ultimate authority of the General Partner. However, the General Partner is required to receive the consent of the Advisor prior to taking certain significant actions, including but not limited to the disposition of mortgages, any transaction or agreement with the General Partner or its affiliates, or any material change as to policies regarding distributions or reserves of the Partnership (collectively the "Consent Rights"). The Advisor is permitted and has delegated the performance of services to CRIIMI MAE Services Limited Partnership ("CMSLP"), a subsidiary of CRIIMI MAE, pursuant to a sub-management agreement (the "Sub-Advisory Agreement"). The general partner and limited partner of CMSLP are wholly-owned subsidiaries of CRIIMI MAE. The delegation of such services by the Advisor to CMSLP does not relieve the Advisor of its obligation to perform such services. Furthermore the Advisor has retained its Consent Rights. Prior to December 1993, the Partnership was engaged in the business of originating and acquiring government insured mortgage loans ("Insured Mortgages"). The Partnership's Investment in Insured Mortgages is comprised of participation certificates evidencing a 100 % undivided beneficial interest in government insured multifamily mortgages issued or sold pursuant to Federal Housing Administration ("FHA") programs ("FHA-Insured Certificates") and mortgage-backed securities guaranteed by the Government National Mortgage Association ("GNMA") ("GNMA Mortgage-Backed Securities"). In accordance with the terms of the Partnership Agreement, the Partnership is no longer authorized to originate or acquire Insured Mortgages and, consequently, its primary objective is to manage its portfolio of mortgage investments, all of which are insured under Section 221(d)(4) or Section 231 of the National Housing Act of 1937, as amended (the "National Housing Act"). The Partnership Agreement states that the Partnership will terminate on December 31, 2009, unless terminated earlier under the provisions thereof. The Partnership is required, pursuant to the Partnership Agreement, to dispose of its assets prior to this date. As the Partnership continues to liquidate its mortgage investments and Unitholders receive distributions 8 AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. NOTES TO FINANCIAL STATEMENTS (Unaudited) of return of capital and taxable gains, Unitholders should expect a reduction in earnings and distributions due to the decreasing mortgage base. Based upon the current level of interest rates, the recent trend in mortgage prepayments is expected to continue. Such mortgage prepayments, if continued at the recent trend, will likely result in a termination and liquidation of the Partnership significantly earlier than the December 2009 stated termination date. Upon the termination and liquidation of the Partnership distributions to Unitholders will be made in accordance with the terms of the Partnership Agreement. A final distribution to Unitholders will be based on the Partnership's remaining net assets after deducting and setting aside amounts required to satisfy and discharge any existing Partnership obligations and expenses, and such distribution to Unitholders is likely to be substantially less than the amount referenced in limited partners' equity in the Partnership's financial statements. 2. BASIS OF PRESENTATION The Partnership's financial statements are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of the General Partner, the accompanying unaudited financial statements contain all adjustments of a normal recurring nature necessary to present fairly the financial position of the Partnership as of June 30, 2004, and the results of its operations for the three and six months ended June 30, 2004 and 2003 and its cash flows for the six months ended June 30, 2004 and 2003. These unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. While the General Partner believes that the disclosures presented are adequate to make the information not misleading, these financial statements should be read in conjunction with the financial statements and the notes to the financial statements included in the Partnership's Annual Report on Form 10-K for the year ended December 31, 2003. 3. INVESTMENT IN GNMA MORTGAGE-BACKED SECURITIES AND FHA-INSURED CERTIFICATES Listed below is the Partnership's aggregate investment in GNMA Mortgage-Backed Securities and FHA-Insured Certificates:

(1) In May 2004, the mortgage on Waterford Green Apartments was prepaid. The Partnership received net proceeds of approximately $6.6 million and recognized a gain of approximately $923,000 for the three and six months ended June 30, 9 AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. NOTES TO FINANCIAL STATEMENTS (Unaudited) 2004. A distribution of approximately $0.455 per Unit related to the prepayment of this mortgage was declared in May and a distribution of approximately $0.07 per Unit for additional proceeds received related to the Partnership's participation interest in this mortgage was declared in June. Both distributions were paid to Unitholders in August 2004. (2) In May 2004, the mortgage on Northwood Place was prepaid. The Partnership received net proceeds of approximately $4.3 million and recognized a loss of approximately $51,000 for the three and six months ended June 30, 2004. A distribution of approximately $0.345 per Unit related to the prepayment of this mortgage was declared in June and paid to Unitholders in August 2004. (3) In June 2004, the mortgage on Stafford Towers was prepaid. The Partnership received net proceeds of approximately $303,000 and recognized a loss of approximately $21,000 for the three and six months ended June 30, 2004. A distribution of approximately $0.02 per Unit related to the prepayment of this mortgage was declared in July and is expected to be paid to Unitholders in November 2004. (4) In July 2004, the GNMA security secured by the mortgage on Oak Forest Apartments II was sold, with the consent of the Advisor. The Partnership received net proceeds of approximately $10.6 million and expects to recognize a gain of approximately $552,000 in the third quarter of 2004. A distribution of approximately $0.84 per Unit related to the sale of this mortgage was declared in July and is expected to be paid to Unitholders in November 2004. As of August 1, 2004, all of the GNMA Mortgage-Backed Securities and FHA-Insured Certificates are current with respect to the payment of principal and interest. 4. INVESTMENT IN FHA-INSURED LOANS Listed below is the Partnership's aggregate investment in FHA-Insured Loans:

(1) In January 2004, HUD transferred assignment proceeds to the Partnership in the form of a 5.75% debenture, with a face value of approximately $3.5 million, in exchange for the mortgage on Kaynorth Apartments. Since the mortgage on Kaynorth Apartments was beneficially owned 50% by the Partnership and 50% by American Insured Mortgage Investors ("AIM 84"), approximately $1.7 million of the debenture face value was due to AIM 84. See further discussion in Note 5. (2) In February 2004, the mortgages on Cobblestone Apartments and The Plantation were sold, with the consent of the Advisor. The Partnership received aggregate net proceeds of approximately $9.6 million and recognized aggregate gains of approximately $386,000 for the six months ended June 30, 2004. The aggregate distribution of approximately $0.76 per Unit related to the sale of these two mortgages was declared in February 2004 and paid to Unitholders in May 2004. 5. INVESTMENTS IN DEBENTURES, DUE TO AFFILIATE AND OTHER The Partnership, as the mortgagee, had the right to assign mortgages to the United States Department of Housing and Urban Development ("HUD") under the Section 221(g)(4) program of the National Housing Act (the "Section 221 Program.") at the expiration of 20 years from the date of final endorsement ("Anniversary Date"). The Partnership, as the mortgagee, could exercise its option to put a mortgage to HUD during the one year period subsequent to the Anniversary Date. This assignment procedure was applicable to an Insured Mortgage which had a firm or conditional commitment for HUD insurance benefits on or before November 30, 1983. A mortgagee electing to assign an Insured Mortgage to HUD received, in exchange therefore, a debenture. As of June 30, 2004, the Partnership no longer holds mortgage investments eligible for assignment to HUD under the Section 221 program. The following is a discussion of debentures received in exchange for mortgages assigned to HUD under the Section 221 Program: 10 AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. NOTES TO FINANCIAL STATEMENTS (Unaudited) Debenture and due to affiliate ------------------------------ Listed below are debentures redeemed by HUD in January 2004. The Partnership received aggregate proceeds of approximately $10.6 million, which included the face value of the debentures, plus accrued interest. The debentures paid interest semi-annually on January 1 and July 1. Since the mortgages listed were beneficially owned 50% by the Partnership and 50% by AIM 84, an affiliate of the Partnership, approximately $5.3 million of the proceeds were transferred to AIM 84. A distribution of the remaining $5.3 million or approximately $0.42 per Unit was declared in January 2004 and paid to Unitholders in May 2004.

In January 2004, HUD issued a 5.75% debenture to the Partnership in exchange for the mortgage on Kaynorth Apartments. The face value of the debenture was approximately $3.5 million and pays interest semi-annually on January 1 and July 1. The Partnership recognized a gain of approximately $246,000 in the first quarter of 2004 related to this assignment. This mortgage was beneficially owned 50% by the Partnership and 50% by AIM 84. In February 2004, the Partnership, with the consent of the Advisor, sold AIM 84's 50% interest in this debenture and subsequently transferred the cash proceeds, which included the face value of the debenture, plus accrued interest, of approximately $1.8 million to AIM 84. The fair value of this debenture, of approximately $1.7 million, was included in Investment in Debentures on the Partnership's balance sheet as of June 30, 2004. Other ----- In January 2004, HUD also redeemed a 6.375% debenture held by a third party beneficiary. The debenture was issued by HUD in May 2003, in exchange for the assignment of the mortgage on The Executive House. The Partnership received proceeds of approximately $836,000 which included the Partnership's portion of the face value of the debenture, plus accrued interest. A distribution of approximately $0.065 per Unit was declared in February 2004 and paid to Unitholders in May 2004. The debenture was held by an unrelated third party and the face amount of approximately $811,000, plus accrued interest, due to the Partnership was included in Receivables and Other Assets on the Partnership's balance sheet as of December 31, 2003. 11 AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. NOTES TO FINANCIAL STATEMENTS (Unaudited) 6. DISTRIBUTIONS TO UNITHOLDERS The distributions paid or accrued to Unitholders on a per Unit basis for the six months ended June 30, 2004 and 2003 are as follows: 2004 2003 ----- ---- Quarter ended March 31 $2.010 (1) $0.310 (3) Quarter ended June 30 0.925 (2) 0.255 (4) ------ ------ $2.935 $0.565 ====== ====== The following disposition proceeds are included in the distributions listed above:

The basis for paying distributions to Unitholders is net proceeds from mortgage and/or debenture dispositions, if any, and cash flow from operations, which includes regular interest income and principal from Insured Mortgages and interest on debentures. Although the Insured Mortgages pay a fixed monthly mortgage payment and the debentures have a fixed semi-annual interest payment, the cash distributions paid to the Unitholders will vary during each quarter due to (1) the fluctuating yields in the short-term money market where the monthly mortgage payments and debenture interest are temporarily invested prior to the payment of quarterly distributions, (2) the reduction in the asset base and monthly mortgage payments resulting from monthly mortgage payments received or mortgage and debenture dispositions, (3) variations in the cash flow attributable to the delinquency or default of Insured Mortgages and professional fees and foreclosure costs incurred in connection with those Insured Mortgages and (4) variations in the Partnership's operating expenses. As the Partnership continues to liquidate its mortgage investments and Unitholders receive distributions of return of capital and taxable gains, Unitholders should expect a reduction in earnings and distributions due to the decreasing mortgage base. Based upon the current level of interest rates, the recent trend in mortgage prepayments is expected to continue. Such mortgage prepayments, if continued at the recent trend, will likely result in a termination and liquidation of the Partnership significantly earlier than the December 2009 stated termination date. Upon the termination and liquidation 12 AMERICAN INSURED MORTGAGE INVESTORS - SERIES 85, L.P. NOTES TO FINANCIAL STATEMENTS (Unaudited) of the Partnership distributions to Unitholders will be made in accordance with the terms of the Partnership Agreement. A final distribution to Unitholders will be based on the Partnership's remaining net assets after deducting and setting aside amounts required to satisfy and discharge any existing Partnership obligations and expenses, and such distribution to Unitholders is likely to be substantially less than the amount referenced in limited partners' equity in the Partnership's financial statements. 7. TRANSACTIONS WITH RELATED PARTIES The General Partner and certain affiliated entities earned or received compensation or payments for services from the Partnership as follows: COMPENSATION PAID OR ACCRUED TO RELATED PARTIES -----------------------------------------------

(1) The General Partner, pursuant to the Partnership Agreement, is entitled to receive 3.9% of the Partnership's income, loss, capital and distributions, including, without limitation, the Partnership's adjusted cash from operations and proceeds of mortgage prepayments, sales or insurance (as defined in the Partnership Agreement). (2) The Advisor is entitled to an asset management fee equal to 0.95% of total invested assets (as defined in the Partnership Agreement). CMSLP is entitled to a fee of 0.28% of total invested assets from the Advisor's asset management fee. Of the amounts paid to the Advisor, CMSLP earned a fee equal to $23,815 and $55,239 for the three and six months ended June 30, 2004, respectively and $46,305 and $94,477 for the three and six months ended June 30, 2003, respectively. The general partner and limited partner of CMSLP are wholly owned subsidiaries of CRIIMI MAE. (3) CRIIMI MAE Management, Inc., an affiliate of the General Partner, is reimbursed for personnel and administrative services on an actual cost basis. 13 PART I. FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS. When used in this Quarterly Report on Form 10-Q, the words "believe," "anticipate," "expect," "contemplate," "may," "will," and similar expressions are intended to identify forward-looking statements. Statements looking forward in time are included in this Quarterly Report on Form 10-Q pursuant to the "safe harbor" provision of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially. Accordingly, the following information contains or may contain forward-looking statements: (1) information included in this Quarterly Report on Form 10-Q, including, without limitation, statements made under Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, (2) information included or incorporated by reference in prior and future filings by the Partnership (defined below) with the Securities and Exchange Commission ("SEC") including, without limitation, statements with respect to growth, projected revenues, earnings, returns and yields on its portfolio of mortgage assets, the impact of interest rates, costs and business strategies and plans and (3) information contained in written material, releases and oral statements issued by or on behalf of, the Partnership, including, without limitation, statements with respect to growth, projected revenues, earnings, returns and yields on its portfolio of mortgage assets, the impact of interest rates, costs and business strategies and plans. Factors which may cause actual results to differ materially from those contained in the forward-looking statements identified above include, but are not limited to (i) regulatory and litigation matters, (ii) interest rates, (iii) trends in the economy, (iv) prepayment of mortgages, (v) defaulted mortgages, (vi) errors in servicing defaulted mortgages and (vii) sales of mortgage investments below fair market value. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only of the date hereof. The Partnership undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. General ------- The Partnership's business consists of holding government insured mortgage investments ("Insured Mortgages") primarily on multifamily housing properties, and distributing the payments of principal and interest on such mortgage investments, including debentures issued by the United States Department of Housing and Urban Development ("HUD") in exchange for such mortgages, to the holders of its depository units of limited partnership interests ("Unitholders"). CRIIMI, Inc., a wholly-owned subsidiary of CRIIMI MAE Inc. ("CRIIMI MAE"), acts as the General Partner (the "General Partner") for the Partnership and holds a partnership interest of 3.9%. The Partnership's primary source of revenue and cash is mortgage interest income from its Insured Mortgages. The General Partner is required to receive the consent of AIM Acquisition Partners L.P., the advisor (the "Advisor") to the Partnership, prior to taking certain significant actions, including but not limited to the disposition of mortgages, any transaction or agreement with the General Partner or its affiliates, or any material change as to policies regarding distributions or reserves of the Partnership (collectively the "Consent Rights"). As the Partnership continues to liquidate its mortgage investments and Unitholders receive distributions of return of capital and taxable gains, Unitholders should expect a reduction in earnings and distributions due to the decreasing mortgage base. . Based upon the current level of interest rates, the recent trend in mortgage prepayments is expected to continue. Such mortgage prepayments, if continued at the recent trend, will likely result in a termination and liquidation of the Partnership significantly earlier than the December 2009 stated termination date. Mortgage Investments -------------------- As of June 30, 2004, the Partnership had invested in 9 Insured Mortgages and one debenture with an 14 PART I. FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS aggregate amortized cost of approximately $26.0 million, an aggregate face value of approximately $26.2 million and an aggregate fair value of approximately $26.7 million, as compared to December 31, 2003, when the Partnership had invested in 15 Insured Mortgages and five debentures with an aggregate amortized cost of approximately $51.5 million, an aggregate face value of approximately $51.6 million and an aggregate fair value of approximately $52.4 million. During the first quarter of 2004, two Insured Mortgages were sold, five debentures were redeemed and one debenture was issued as assignment proceeds for one mortgage with an aggregate amortized cost of approximately $14.4 million, an aggregate face value of approximately $14.1 million. The following is an explanation of the Insured Mortgage dispositions during the second quarter of 2004: In May 2004, the mortgage on Waterford Green Apartments was prepaid. The Partnership received net proceeds of approximately $6.6 million and recognized a gain of approximately $923,000 for the three and six months ended June 30, 2004. A distribution of approximately $0.455 per Unit related to the prepayment of this mortgage was declared in May and a distribution of approximately $0.07 per Unit of additional proceeds received related to participation interest on this mortgage was declared in June. Both distributions were paid to Unitholders in August 2004. In May 2004, the mortgage on Northwood Place was prepaid. The Partnership received net proceeds of approximately $4.3 million and recognized a loss of approximately $51,000 for the three and six months ended June 30, 2004. A distribution of approximately $0.345 per Unit related to the prepayment of this mortgage was declared in June and paid to Unitholders in August 2004. In June 2004, the mortgage on Stafford Towers was prepaid. The Partnership received net proceeds of approximately $303,000 and recognized a loss of approximately $21,000 for the three and six months ended June 30, 2004. A distribution of approximately $0.02 per Unit related to the prepayment of this mortgage was declared in July and is expected to be paid to Unitholders in November 2004. In July 2004, the GNMA security secured by the mortgage on Oak Forest Apartments II was sold, with the consent of the Advisor. The Partnership received net proceeds of approximately $10.6 million and expects to recognize a gain of approximately $552,000 in the third quarter of 2004. A distribution of approximately $0.84 per Unit related to the sale of this mortgage was declared in July and is expected to be paid to Unitholders in November 2004. After the sale of the Insured Mortgage in July 2004 the Partnership had invested in 8 Insured Mortgages and one debenture with an aggregate face value of approximately $15.6 million. As of August 1, 2004, all of the Insured Mortgages are current with respect to the payment of principal and interest. Results of Operations --------------------- Net earnings increased by approximately $45,000 for the three months ended June 30, 2004, as compared to the corresponding period in 2003, primarily due to an increase in gains on mortgage dispositions, and a decrease in expenses largely offset by a decrease in mortgage investment income. Net earnings decreased by approximately $176,000 for the six months ended June 30, 2004, as compared to the corresponding period in 2003, primarily due to a decrease in mortgage investment income partially offset by an increase in gains on mortgage dispositions and a decrease in expenses. Mortgage investment income decreased by approximately $652,000 and $1.2 million for the three and six months ended June 30, 2004, respectively, as compared to the corresponding periods in 2003, primarily due to a reduction in the mortgage base. The mortgage base decreased as a result of 13 mortgage dispositions with an aggregate principal balance of approximately $35.5 million, representing an 15 PART I. FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued approximate 59% decrease in the aggregate principal balance of the total mortgage portfolio since June 30, 2003. Interest and other income increased by approximately $15,000 and $56,000 for the three and six months ended June 30, 2004, respectively, as compared to the corresponding periods in 2003, primarily due to an increase in debenture interest and due to variations in the amounts and the timing of the temporary investment of mortgage disposition proceeds prior to distribution. Asset management fees decreased by approximately $76,000 and $133,000 for the three and six months ended June 30, 2004, respectively, as compared to the corresponding periods in 2003, primarily due to the reduction in the mortgage base, as previously discussed. General and administrative expenses decreased by approximately $48,000 and $67,000 for the three and six months ended June 30, 2004, respectively, as compared to the corresponding periods in 2003, primarily due to the reduction in the mortgage base. Net gains on mortgage dispositions increased by approximately $558,000 and $738,000 for the three and six months ended June 30, 2004, respectively, as compared to the corresponding period in 2003. During the three months ended March 31, 2004, the Partnership recognized a gain of approximately $246,000 from the assignment of one mortgage and gains of approximately $386,000 from the sale of two mortgages. During the three months ended June 30, 2004, the Partnership recognized gains of approximately $851,000 from the prepayment of three mortgages. During the first three months of 2003, the Partnership recognized a gain of approximately $93,000 from the prepayment of one mortgage and gains of approximately $359,000 from the assignment of two mortgages. During the three months ended June 30, 2003, the Partnership recognized gains of approximately $196,000 from the prepayment of three mortgages and gains of approximately $97,000 from the assignment of one mortgage. Liquidity and Capital Resources ------------------------------- The Partnership's operating cash receipts, derived from payments of principal and interest on Insured Mortgages, interest on debentures and cash receipts from interest on short-term investments, were sufficient during the six months ended June 30, 2004 to meet operating requirements. The basis for paying distributions to Unitholders is net proceeds from mortgage and/or debenture dispositions, if any, and cash flow from operations, which includes regular interest income and principal from Insured Mortgages and interest on debentures. Although the Insured Mortgages pay a fixed monthly mortgage payment and the debentures have a fixed semi-annual interest payment, the cash distributions paid to the Unitholders will vary during each quarter due to (1) the fluctuating yields in the short-term money market where the monthly mortgage payments and debenture interest are temporarily invested prior to the payment of quarterly distributions, (2) the reduction in the asset base and monthly mortgage payments resulting from monthly mortgage payments received or mortgage and debenture dispositions, (3) variations in the cash flow attributable to the delinquency or default of Insured Mortgages and professional fees and foreclosure costs incurred in connection with those Insured Mortgages and (4) variations in the Partnership's operating expenses. As the Partnership continues to liquidate its mortgage investments and Unitholders receive distributions of return of capital and taxable gains, Unitholders should expect a reduction in earnings and distributions due to the decreasing mortgage base. Based upon the current level of interest rates, the recent trend in mortgage prepayments is expected to continue. Such mortgage prepayments, if continued at the recent trend, will likely result in a termination and liquidation of the Partnership significantly earlier than the December 2009 stated termination date. Upon the termination and liquidation of the Partnership distributions to Unitholders will be made in accordance with the terms of the Partnership Agreement. A final distribution to Unitholders will be based on the Partnership's remaining net assets after deducting and setting aside amounts required to satisfy and discharge any existing Partnership obligations and expenses, 16 PART I. FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued and such distribution to Unitholders is likely to be substantially less than the amount referenced in limited partners' equity in the Partnership's financial statements. Net cash provided by operating activities decreased by approximately $576,000 for the six months ended June 30, 2004, as compared to the corresponding period in 2003, primarily due to a decrease in mortgage investment income, partially offset by decreases in asset management fee and general and administrative expenses. Net cash provided by investing activities increased by approximately $21.7 million for the six months ended June 30, 2004, as compared to the corresponding period in 2003, primarily due to increases in proceeds received from mortgage prepayments and sales and net debenture redemptions, partially offset by a decrease in proceeds received from mortgage assignments. Net cash used in financing activities increased by approximately $13.7 million for the six months ended June 30, 2004, as compared to the corresponding period in 2003, due to an increase in the amount of distributions paid to partners in the first six months of 2004 compared to the same period in 2003. Critical Accounting Policies ---------------------------- The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. The Partnership continually evaluates the estimates used to prepare the financial statements, and updates those estimates as necessary. In general, management's estimates are based on historical experience, on information from third parties, and other various assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ materially from those estimates. Management considers an accounting estimate to be critical if: o it requires assumptions to be made that were uncertain at the time the estimate was made; and o changes in the estimate or different estimates that could have been selected and could have a material impact on the Partnership's results of operations or financial condition. The Partnership's primary critical accounting estimate relates to the determination of fair values for Insured Mortgages. The Partnership estimates the fair value of its Insured Mortgages internally. The Partnership uses a discounted cash flow methodology to estimate the fair value. This requires the Partnership to make certain estimates regarding discount rates and expected prepayments. The cash flows were discounted using a discount rate that, in the Partnership's view, was commensurate with the market's perception of risk and value. The Partnership used a variety of sources to determine its discount rate including: (i) institutionally-available research reports, (ii) communications with dealers and active insured mortgage security investors regarding the valuation of comparable securities and (iii) recent transactions. Increases in the discount rate used by the Partnership would generally result in a corresponding decrease in the fair value of the Partnership's insured mortgages. Decreases in the discount rate used by the Partnership would generally result in a corresponding increase in the fair value of the Partnership's insured mortgages. The Partnership also makes certain assumptions regarding the prepayment speeds of its Insured Mortgages. In a low interest rate environment, mortgages are more likely to prepay even if the mortgage contains prepayment penalties. In general, if the Partnership increases its assumed prepayment speed, the fair value of the Insured Mortgages will decrease. If the Partnership decreases its assumed prepayment speed, the fair value of the Insured Mortgages will increase. 17 PART I. FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Management has determined that there has not been a material change as of June 30, 2004, in market risk from the information provided as of December 31, 2003 in the Partnership's Annual Report on Form 10-K as of December 31, 2003. ITEM 4. CONTROLS AND PROCEDURES The General Partner carried out an evaluation, under the supervision and with the participation of the General Partner's management, including the General Partner's Chairman of the Board and Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), of the effectiveness of its disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended. Based on that evaluation, the General Partner's CEO and CFO concluded that its disclosure controls and procedures were effective as of the end of the period covered by this report. There have been no significant changes in the General Partner's internal controls over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are likely to materially affect, internal controls over financial reporting. 18 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits -------- Exhibit No. Purpose ----------- 31.1 Certification pursuant to the Exchange Act Rule 13a-14(a) from Barry S. Blattman, Chairman of the Board and Chief Executive Officer of the General Partner (Filed herewith). 31.2 Certification pursuant to the Exchange Act Rule 13a-14(a) from Cynthia O. Azzara, Executive Vice President, Chief Financial Officer and Treasurer of the General Partner (Filed herewith). 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 from Barry S. Blattman, Chairman of the Board and Chief Executive Officer of the General Partner (Furnished herewith). 32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 from Cynthia O. Azzara, Executive Vice President, Chief Financial Officer and Treasurer of the General Partner (Furnished herewith). (b) Reports on Form 8-K Date ---- April 22, 2004 To report a press release issued on April 21, 2004 announcing the April 2004 distribution to the Partnership's Unitholders. May 6, 2004 To report a press release issued on May 4, 2004 announcing the Partnership's first quarter financial results. June 2, 2004 To report a press release issued on May 19, 2004 announcing the May 2004 distribution to the Partnership's Unitholders. June 21, 2004 To report a press release issued on June 21, 2004 announcing the June 2004 distribution to the Partnership's Unitholders. 19 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AMERICAN INSURED MORTGAGE INVESTORS L.P. - SERIES 85 (Registrant) By: CRIIMI, Inc. General Partner /s/Cynthia O. Azzara August 12, 2004 -------------------------------- ---------------- Cynthia O. Azzara DATE Executive Vice President, Chief Financial Officer and Treasurer (Principal Accounting Officer)

AMERICAN INSURED MORTGAGE INVESTORS SERIES 85 L P 10-Q