ITEM 1 - BUSINESS
General
We are a Delaware limited partnership formed on March 30, 2004 by our General Partner, LEAF Financial Corporation (our “General Partner”), which manages us. Our General Partner is a subsidiary of Resource America, Inc. (“RAI”). RAI is a publicly-traded company (NASDAQ: REXI) that uses industry specific expertise, to evaluate, originate, service, and manage investment opportunities through its commercial finance, real estate, and financial fund management segments. Through our offering termination date of October 13, 2006, we raised $60.0 million by selling 600,000 of our limited partner units. We commenced operations in April 2005.
We were expected to have a minimum of a nine-year life, consisting of an offering period of up to two years, a five year reinvestment period and a subsequent liquidation period of two years, during which our leases and secured loans will either mature or be sold. In the event we are unable to sell our leases and secured loans during the liquidation period, to the extent that there is excess cash, we expect to continue to return capital to our partners as those leases and loans mature. All of our leases and loans mature by the end of 2029. We entered our liquidation period in October 2011 and will terminate on December 31, 2029, unless sooner dissolved or terminated as provided in our Limited Partnership Agreement.
We acquired a diversified portfolio of new, used, or reconditioned equipment that we lease to third-parties. We also acquired portfolios of equipment subject to existing leases from other equipment lessors. Our financings were typically acquired from our General Partner. In addition, we made secured loans to end users to finance their purchase of equipment. We structured our secured loans so that, in an economic sense, there was no difference to us between a secured loan and a full payout equipment lease. We financed business-essential equipment including, but not limited to, computers, copiers, office furniture, water filtration systems, machinery used in manufacturing and construction, medical equipment and telecommunications equipment. We focus on the small to mid-size business market, which generally includes businesses with:
•
500 or fewer employees;
•
$1 billion or less in total assets; or
•
$100 million or less in total annual sales.
Index
Our principal objective is to generate regular cash distributions to our limited partners.
Our leases consist of direct financing and operating leases as defined by accounting principles generally accepted in the United States of America (“U.S. GAAP”). Under the direct financing method of accounting, interest income (the excess of the aggregate future rentals and estimated unguaranteed residuals upon expiration of the lease over the related equipment cost) is recognized over the life of the lease using the interest method. Under the operating method, the cost of the leased equipment, including acquisition fees associated with lease placements, is recorded as an asset and depreciated on a straight-line basis over its estimated useful life. Rental income on operating leases consists primarily of monthly periodic rentals due under the terms of the leases. Generally, during the lease terms of existing operating leases, we will not recover all of the cost and related expenses of rental equipment and, therefore, we are prepared to remarket the equipment in future years. We discontinue the recognition of revenue for leases and loans for which payments are more than 90 days past due. These assets are classified as non-accrual.
As discussed further in ITEM 7, the recent economic recession in the United States has adversely affected our operations as a result of higher delinquencies and may continue to do so as the economy recovers.
Available Information
We file annual, quarterly and current reports and other information with the SEC. The public may read and copy information we file with the SEC at the SEC’s public reference room at 100 F Street, NE, Washington, D.C. 20549, on official business days during the hours of 10:00 am and 3:00 pm. The public may obtain information on the operations of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet website that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The internet address of the SEC website is http://www.sec.gov. Our General Partner’s internet address is http://www.LEAFFinancial.com. We make our SEC filings available free of charge on or through our General Partner’s internet website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. We are not incorporating by reference in this report any material from our General Partner’s website.
Agreements with our General Partner
We do not directly employ any persons to manage or operate our business. These functions are provided by our General Partner and employees of our General Partner and/or its affiliates. We reimburse our General Partner and/or its affiliates for all direct and indirect costs of services provided, including the cost of employees and benefits properly allocable to us and all other expenses necessary or appropriate for the conduct of our business.
Competition
The equipment leasing business is highly fragmented and competitive. We acquire equipment from our General Partner and its affiliates. Our General Partner and its affiliates compete with:
•
a large number of national, regional and local banks, savings banks, leasing companies and other financial institutions;
•
captive finance and leasing companies affiliated with major equipment manufacturers; and
•
other sources of equipment lease financing, including other publicly-offered partnerships.
Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we have. Competition with these entities may reduce the creditworthiness of potential lessees or borrowers to whom we have access or decrease our yields. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. A lower cost of funds could enable a competitor to offer leases or loans at rates which are less than ours, potentially forcing us to lower our rates or lose origination volume.
Employees
As is commonly the case with limited partnerships, we do not directly employ any of the persons responsible for our management or operations. Rather, the personnel of our General Partner and/or its affiliates manage and operate our business. Officers of our General Partner may spend a substantial amount of time managing the business and affairs of our General Partner and its affiliates and may face a conflict regarding the allocation of their time between our business and affairs and their other business interests. The officers of our General Partner who provide services to us are not required to work full time on our affairs. These officers may devote significant time to the affairs of our General Partner’s affiliates and be compensated by these affiliates for the services rendered to them. There may be significant conflicts between us and affiliates of our General Partner regarding the availability of these officers to manage us.
Index
ITEM 1A
ITEM 1A - RISK FACTORS
Risk factors have been omitted as permitted under rules applicable to smaller reporting companies.
ITEM 2
ITEM 2 - PROPERTIES
We do not own or lease any real property.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
We are not subject to any pending material legal proceedings.
Index
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our limited partner units are not publicly traded. There is no market for our limited partner units and it is unlikely that any will develop. The following table shows the number of equity security holders, including our General Partner with respect to limited partner units it purchased.
Total distributions paid to limited partners for the years ended December 31, 2013 and 2012 were $1.1 million and $1.2 million, respectively. These distributions were paid on a monthly basis to our limited partners at rate of approximately 2% of their original capital contribution to us in 2013 and 2012. However, as a result of the continued liquidation of the Fund’s investment portfolio, the Fund notified its limited partners that it would cease making regular cash distributions in November 2013.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
Not applicable.
Index
ITEM 7
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion provides an analysis of our operating results, an overview of our liquidity and capital resources and other items related to us. This discussion and analysis should be read in conjunction with Item 1 and the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for the year ended December 31, 2013.
As used herein, the terms “we,” “us,” or “our” refer to Lease Equity Appreciation Fund II, L.P. and subsidiary.
Fund Summary
Prior to entering the liquidation period in October 2011, we acquired a diversified portfolio of new, used or reconditioned equipment that we lease to third parties. We also acquired portfolios of equipment subject to existing leases from other equipment lessors. Our financings were typically acquired from our General Partner.
When we commenced operations in 2005, the United States economy was experiencing strong growth, an abundance of liquidity in the debt markets and historically low credit losses. However, it is widely believed that the United States economy over the past few years has suffered through the worst economic recession in over 75 years. The recession has been severe and its consequences broadly felt. Many well-known major financial institutions failed and others had to be bailed out. Unemployment soared to generational highs and has remained at such levels. Bank lending was severely reduced and became more expensive. In recent years, banks became much more reluctant to lend, and when they did, it became more expensive to borrow. If existing loans came up for renewal and were extended, they were written for reduced amounts and at higher interest rates. Also, lenders insisted on ever-tighter covenants around delinquencies and write-offs that made it more difficult to remain in compliance. The recession caused increased delinquencies and losses greater than we had projected requiring us to repay our lender the amounts borrowed against delinquent leases in addition to anticipated principal pay down.
Our General Partner has deferred our payment of fees and reimbursement of expenses totaling approximately $16.3 million from inception through December 31, 2013, in order to preserve cash for us. Additionally, our General Partner waived approximately $220,000 in management fees for the 12 month period ended December 31, 2013 and has waived approximately $4.2 million on a cumulative basis. The General Partner has also waived all future management fees.
To date, limited partners have received total distributions ranging from approximately 32% to 44% of their original amount invested, depending upon when the investment was made. In October 2011, we entered the liquidation phase of the partnership, subsequent to which we are prohibited from acquiring additional leases and loans. Accordingly, cash flows on our existing investment in leases and loans will be used to repay our obligations. The Fund is in its liquidation process which will continue until all of the leases are collected or sold and our debts are paid. Distributions to our limited partners were made in 2013 and 2012 at a rate of 2.0% of their original capital invested. As a result of the continued liquidation of the Fund’s investment portfolio, the Fund notified its limited partners that it will cease making regular cash distributions in November 2013.
General Economic Overview
For the quarter ended December 31, 2013, U. S. economic activity showed overall growth and improvement in many sectors of the economy. These improvements provided the background and support for the Federal Reserve to announce that it would begin the highly anticipated tapering of asset purchases under the Quantitative Easing program, recognition of economic improvement and stability. Still looming over the economy is the debate over the debt ceiling and the implementation of the Affordable Care Act and the impact of each on economic activity which is likely to be felt in the beginning of 2014.
Some specific key economic indicators and reports that were released in the fourth quarter of 2013 that have specific relevance to small to medium size business performance are summarized below. The indicators show overall positive trends in the economy. These indicators have especially important relevance to the LEAF Funds as loans and leases to small and medium size businesses comprise the majority of the LEAF Funds portfolios.
· The December 2013 Thomson Reuters/PayNet Small Business Lending Index which measures the volume of lending to small businesses rose 5% as compared to the year earlier period and increased 6% as compared to the prior month. At the same time the Thomson Reuters/PayNet Small Business Delinquency Index for December 2013 showed a 13% drop in the delinquency rate as compared to the year earlier period.
· The National Federation of Independent Business reported that its Small Business Optimism Index increased in December 2013. While the Index remains below pre-recession levels the December 2013 increase continues a yearlong positive trend. The Index measures ten different items including small business sentiment about business expansion, hiring, and sales trends. Notably there was evidence of significant increases in capital spending.
Index
· The Monthly Confidence Index reported by The Equipment Leasing & Finance Foundation was 55.8 (over 50 is considered positive) which was a slight decline from the previous month, however, new business volume reported in December 2013 showed month over month and year over year increases.
· The National Association of Realtors reported that in the Fourth Quarter of 2013 all measures of home sales and housing starts showed increases from the prior year period. These increases included Existing Home Sales, New Single Family Sales, Housing Starts, Single Family and Multifamily Units. Housing is an important economic activity indicator for small businesses as many small businesses including construction related companies and retail businesses rely on housing activity as a significant part of their revenues.
· The S&P Case-Shiller Home Price Indices (another widely followed indicator of housing sector activity) released in December 2013 for the 10-and-20-City Composites showed 13.6% increases year over year for the last 12 months.
· The National Association of Credit Management Index (“CMI”) for December 2013 measured 55.64 (any number over 50 shows an economy in expansion). The factors comprising the CMI include activities like credit extended, credit approval rates, delinquencies, and bankruptcies. The CMI remained over 50 throughout 2013 and ended the year higher (55.6) than it started (54.9).
· The December 2013 Institute of Supply Management reported its PMI Index on the manufacturing sector. The PMI Index showed expansion for the seventh straight month and the PMI index registered 57 (any number over 50 indicates growth) which is the second highest reading for 2013 and reflected growth in new orders, production and employment in the manufacturing sector which is home to many small to medium size businesses.
· In December 2013 the unemployment rate dropped to 7.0% from 7.3% in September 2013. As most new employment creation comes from small to medium size businesses this is again another indication of improving conditions in that segment of the economy.
Taken altogether, these indicators point to an economy that is continuing to grow steadily but slowly which is positive for the small to medium size businesses that comprise the majority of the LEAF Funds’ portfolios.
Finance Receivables and Asset Quality
Information about our portfolio of leases and loans is as follows (dollars in thousands):
(a) Located in the 50 states as well as the District of Columbia and Puerto Rico. No individual end user or single piece of equipment accounted for more than 13% of our portfolio based on original cost of the equipment (see Note 2 in the Notes to the Consolidated Financial Statements for more information).
Index
Portfolio Performance
The table below provides information about our finance receivables including non-performing assets, which are those assets that are not accruing income due to non-performance or impairment (dollars in thousands):
We managed our credit risk by adhering to strict credit policies and procedures, and closely monitoring our receivables. Our General Partner, the servicer of our leases and loans, responded to the recent economic recession in part, by implementing early intervention techniques in collection procedures.
Our allowance for credit losses is our estimate of losses inherent in our commercial finance receivables. The allowance is based on factors which include our historical loss experience on equipment finance portfolios we manage, an analysis of contractual delinquencies, current economic conditions and trends and equipment finance portfolio characteristics, adjusted for recoveries. In evaluating historic performance, we perform a migration analysis, which estimates the likelihood that an account progresses through delinquency stages to ultimate charge-off. Our policy is to charge off to the allowance those financings which are in default and for which management has determined the probability of collection to be remote. Substantially all of our assets are collateral for our debt and, therefore, significantly greater delinquencies than anticipated will have an adverse impact on our cash flow and distributions to our partners.
We focused on financing equipment used by small to mid-sized businesses. Because the Fund is in the liquidation phase, the portfolio of outstanding leases and loans has decreased, resulting in a reduction in the allowance for credit losses and non-performing assets. However, the lingering effects of the economic recession has made it difficult for some of our customers to make payments on their financings with us on a timely basis, which has adversely affected our operations in the form of higher delinquencies, as evidenced by increases in the allowance for credit losses and non-performing assets as a percentage of finance receivables.
Index
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and cost and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including the allowance for credit losses, the estimated unguaranteed residual values of leased equipment, and the fair value of interest rate swaps. We base our estimates on historical experience, current economic conditions and on various other assumptions that we believe reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We have identified the following policies as critical to our business operations and the understanding of our results of operations.
Investments in Leases and Loans
Our investments in leases and loans consist of direct financing leases, operating leases and loans.
Direct Financing Leases. Certain of our lease transactions are accounted for as direct financing leases (as distinguished from operating leases). Such leases transfer substantially all benefits and risks of equipment ownership to the customer. Our investment in direct financing leases consists of the sum of the total future minimum lease payments receivable plus the estimated unguaranteed residual value of leased equipment, less unearned finance income. Unearned finance income, which is recognized as revenue over the term of the financing by the effective interest method, represents the excess of the total future minimum contracted payments plus the estimated unguaranteed residual value over the cost of the related equipment.
Unguaranteed residual value represents the estimated amount to be received at lease termination from lease extensions or ultimate disposition of the leased equipment. The estimates of residual values are based upon our history with regard to the realization of residuals, available industry data and the General Partner’s senior management’s experience with respect to comparable equipment. The estimated residual values are recorded as a component of investments in leases. Residual values are reviewed periodically to determine if the current estimate of the equipment’s fair market value appears to be below its recorded estimate. If required, residual values are adjusted downward to reflect adjusted estimates of fair market values. Upward adjustments to residual values are not permitted.
Operating Leases. Leases not meeting any of the criteria to be classified as direct financing leases are deemed to be operating leases. Under the accounting for operating leases, the cost of the leased equipment, including acquisition fees associated with lease placements, is recorded as an asset and depreciated on a straight-line basis over the equipment’s estimated useful life, generally up to seven years. Rental income consists primarily of monthly periodic rental payments due under the terms of the leases. We recognize rental income on a straight line basis.
A review for impairment of operating leases is performed whenever events or changes in circumstances indicate that the carrying amount of the operating leases may not be recoverable. We write down our rental equipment to its estimated net realizable value when it is probable that its carrying amount exceeds its fair value and the excess can be reasonably estimated; gains are only recognized upon actual sale of the rental equipment.
Loans. For term loans, the investment in loans consists of the sum of the total future minimum loan payments receivable less unearned finance income. Unearned finance income, which is recognized as revenue over the term of the financing by the effective interest method, represents the excess of the total future minimum contracted loan payments over the cost of the related equipment. For all other loans, interest income is recorded at the stated rate on the accrual basis to the extent that such amounts are expected to be collected.
Allowance for Credit Losses. We evaluate the adequacy of the allowance for credit losses (including investments in leases and loans) based upon, among other factors, management’s historical experience on the portfolios it manages, an analysis of contractual delinquencies, economic conditions and trends, and equipment finance portfolio characteristics, adjusted for expected recoveries. In evaluating historic performance, we perform a migration analysis, which estimates the likelihood that an account progresses through delinquency stages to ultimate charge-off. After an account becomes 180 or more days past due, any remaining balance is fully-reserved less an estimated recovery amount. Generally, past due accounts are referred to our internal recovery group consisting of a team of credit specialists and collectors. The group utilizes several resources in an attempt to maximize recoveries on past due accounts including: 1) initiating litigation against the end user customer and any personal guarantor, 2) referring the account to an outside law firm or collection agency and/or 3) repossessing and remarketing the equipment through third parties. Our policy is to charge off to the allowance those financings which are in default and for which it is probable management will be unable to collect all amounts contractually owed. We discontinue the recognition of revenue for leases and loans for which payments are more than 90 days past due. As of December 31, 2013 and 2012, we had $420,000 and $1.1 million, respectively, of leases and loans on non-accrual status. Payments received while leases and loans are on non-accrual status are recorded as a reduction of principal. Generally, income recognition resumes when a lease or loan becomes less than 90 days delinquent. Fees from delinquent payments are recognized when received and are included in other income.
Index
Results of Operations
Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012
The following summarizes our results of operations for the years ended December 31, 2013 and 2012 (dollars in thousands):
As discussed in more specific detail below, the overall reductions in both revenues and expenses were caused by the significant decrease in the size of the leases and loans portfolio as well as the significant reduction in debt during the year ended December 31, 2013 as compared to the year ended December 31, 2012.
The decrease in total revenues was primarily attributable to the following:
• a decrease in interest on equipment financings and rental income. Our weighted average net investment in financing assets decreased to $8.8 million for the year ended December 31, 2013 as compared to $26.5 million for the year ended December 31, 2012, a decrease of $17.7 million or 67%. As we entered our liquidation phase in October 2011 we are not permitted under the Partnership Agreement to acquire additional leases and loans. Therefore, our revenues are expected to continue to decline as our weighted average net investment in financing assets declines due to the ongoing maturities of our leases and loans.
• Gains on sales of equipment and lease dispositions, net increased $287,000 to a net gain of $427,000 for the year ended December 31, 2013 as compared to a net gain of $140,000 for the year ended December 31, 2012. Gains and losses on sales of equipment may vary significantly from period to period.
• Other income decreased from $514,000 for the year ended December 31, 2012 to $201,000 for the year ended December 31, 2013, a decrease of $313,000 or 61%. The decrease in other income is primarily related to a decrease in late fee income, which is primarily driven by the decrease in the size of our portfolio.
Index
The decrease in total expenses was primarily attributable to the following:
• a decrease in interest expense primarily due to a decrease in average debt outstanding. Weighted average borrowings for the year ended December 31, 2013 were $2.2 million as compared to $21.6 million as of December 31, 2012. Borrowings for the years ended December 31, 2013 and 2012 were at an effective interest rate of 36% and 11%, respectively. We expect our interest expense to continue to decline as our portfolio of leases and loans matures.
• a decrease in interest expense to related party. Interest payments on the note payable were $624,000 and $775,000 for the years ended December 31, 2013 and 2012, respectively.
• a decrease in depreciation on operating leases directly related to a decrease in our investment in operating leases.
• a decrease in provision for credit losses. We provide for credit losses when losses are likely to occur based on a migration analysis of past due payments and economic conditions. This decrease is consistent with the decline in the portfolio of equipment financed assets.
• a decrease in general and administrative expenses and administrative expenses reimbursed to affiliates due to the decrease in the size of our portfolio.
• an increase in loss on derivative activities primarily due to the termination of all hedges in relation to the payoff of the Portigon Financial Services (“Portigon’’), previously known as WestLB AG, term loan.
The net loss per limited partner unit, after the net loss allocated to our General Partner, for the years ended December 31, 2013 and 2012 was $2.47 and $7.08, respectively, based on a weighted average number of limited partner units outstanding of 592,809 each period.
The General Partner has waived all future management fees and, accordingly, we did not incur any asset management fees in 2013 or 2012. Approximately $220,000 on of management fees were waived for the year ended December 31, 2013 and approximately $4.2 million in management fees have been waived through December 31, 2013 on a cumulative basis.
Liquidity and Capital Resources
General
Our major source of liquidity is obtained from the collection of lease and loan payments and the amounts remaining after payments of debt principal and interest on debt. Our other cash requirements, in addition to debt service, are for normal operating expenses, and prior to November 2013, distributions to partners. As noted previously, we notified our limited partners that we will cease making regular cash distributions in November 2013. Accordingly, we plan to fund our other cash requirements for operating expenses from cash remaining after payments for debt service. As noted previously, we entered the liquidation phase in October 2011. Accordingly, we are generally not permitted to purchase any new leases or loans, unless contractually required to as part of an ultimate net loss reserve associated with portfolios of leases and loans previously sold to third parties.
We believe that our future net cash inflows can be estimated as the total scheduled future payments to be received from leases and loans less our debt service payments. At December 31, 2013, the total future minimum lease payments scheduled to be received was $6.1 million, which excludes the $370,000 allowance for credit losses, and we had no borrowings outstanding on our debt facility. We believe at this time that future net cash inflows will be sufficient to either finance operations or meet other debt service requirements as they arise. The following table sets forth our sources and uses of cash for the periods indicated (in thousands):
During the year ended December 31, 2013 cash decreased by $209,000 which was primarily due to net cash provided by our investment in leases and loans of $8.7 million, which were used to repay our debt obligations and support cash distributions to our partners. Our debt repayments of $6.5 million were made with proceeds from our leases and loans and restricted cash related to our Portigon term loan, which we repaid in full in November 2013.
Index
Partners’ distributions paid for the years ended December 31, 2013 and 2012 were $1.1 million and $1.2 million, respectively. Partner distributions were made at a rate of 2.0% of original capital invested with us in 2013 and 2012. Cumulative partner distributions paid from our inception to December 31, 2013 were approximately $21.4 million. However, due to the continued liquidation of the Fund’s investment portfolio, the Fund notified its limited partners that it would cease making regular cash distributions in November 2013.
Our General Partner has waived all future management fees beginning in 2010. Approximately $220,000 of management fees were waived for the year ended December 31, 2013 and approximately $4.2 million have been waived on a cumulative basis.
Our performance is impacted by a number of factors which include: our ability to obtain and maintain debt financing on acceptable terms to build and maintain our equipment finance portfolio; lease and loan defaults by our customers; and prevailing economic conditions. If the current economic recovery falters or reverses, we could continue to experience higher than expected lease and loan defaults and our liquidity could be adversely affected.
Borrowings
Before November 2013, when the remaining balance was paid off in full, we had a term loan with Portigon Financial Services (Portigon or the Lender), previously known as WestLB AG. Interest on originations that were financed prior to March 2009 was calculated at London Interbank Offered Rate (“LIBOR”) plus 1.20% per year. Interest on originations financed under this facility after March 2009 was at a rate of LIBOR plus 2.50% per year. As of December 31, 2013, because there was $0 outstanding related to this facility, no leases, loans, or restricted cash were pledged as collateral under this facility.
In addition to the borrowings discussed above, we owe $5.7 million to Resource Capital Corporation, Inc. (“RSO”) as of December 31, 2013, which is a related entity of ours through common management with RAI. In June 2011, we paid a 1% fee to extend the note maturity date from March 2011 to February 2012 and to reduce the interest rate from 12% to 10% per annum. In February 2012 and January 2013, we incurred additional 1% fees of the outstanding principal amount each period that was paid to RSO to further extend the maturity date of the related party note payable in one-year increments from February 2012 to February 2014. In December 2013, without any additional fees, we extended the maturity date of the related party note payable from February 2014 to February 2015. Interest payments on the note payable were $624,000 and $775,000 for the years ended December 31, 2013 and 2012, respectively.
Liquidity Summary
Substantially all of our leases and loans were financed through the issuance of debt. Repayment of our debt is based on the payments we receive from our customers. If a lease or loan becomes delinquent we must repay our lender, even though our customer has not paid us. Higher-than-expected lease and loan defaults will reduce our liquidity.
Our primary source of liquidity comes from payments on our lease and loan portfolio. Our liquidity has been and could be further adversely affected by higher than expected equipment lease defaults, which results in a loss of revenues. These losses may adversely affect our ability to make distributions to our partners and, if the level of defaults is sufficiently large, may result in our inability to fully recover our investment in the underlying equipment. As our lease portfolio ages, and if the recovery in the United States economy falters for a substantial period of time, we anticipate the need to increase our allowance for credit losses.
Legal Proceedings
We are a party to various routine legal proceedings arising in the ordinary course of our business. Our General Partner believes that none of these actions, individually or in the aggregate, will have a material adverse effect on our financial condition or results of operations.
Recently Issued Accounting Pronouncements
See Note 2 in the Notes to Consolidated Financial Statements for a description of certain new accounting pronouncements that will or may affect our consolidated financial statements.
ITEM 7A
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and Qualitative Disclosures about Market Risk have been omitted as permitted under rules applicable to smaller reporting companies.
Index
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Partners
Lease Equity Appreciation Fund II, L.P. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Lease Equity Appreciation Fund II, L.P. (a Delaware Limited Partnership) and subsidiaries (the “Fund”), as of December 31, 2013 and 2012 and the related consolidated statements of operations, comprehensive loss, changes in partners’ deficit, and cash flows for each of the two years in the period ended December 31, 2013. These financial statements are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Fund’s internal control over financial reporting. Our audits included 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 Fund’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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lease Equity Appreciation Fund II, L.P. and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Philadelphia, Pennsylvania
March 31, 2014
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except unit data)
The accompanying notes are an integral part of these consolidated financial statements.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Loss
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Consolidated Statements of Changes in Partners’ Deficit
(In thousands, except unit data)
The accompanying notes are an integral part of these consolidated financial statements.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
December 31, 2013 and 2012
NOTE 1 - ORGANIZATION AND NATURE OF BUSINESS
Lease Equity Appreciation Fund II, L.P. (the “Fund”) is a Delaware limited partnership formed on March 30, 2004 by its General Partner, LEAF Financial Corporation (the “General Partner”). The General Partner manages the Fund. The General Partner is a subsidiary of Resource America, Inc. (“RAI”). RAI is a publicly-traded company (NASDAQ: REXI) that uses industry specific expertise to evaluate, originate, service and manage investment opportunities through its commercial finance, real estate and financial fund management segments. Through its offering termination date of October 13, 2006, the Fund raised $60.0 million by selling 600,000 of its limited partner units. It commenced operations in April 2005.
The Fund is expected to have a minimum of a nine-year life, consisting of an offering period of up to two years, a five-year reinvestment period and a subsequent liquidation period of two years, during which the Fund’s leases and secured loans will either mature or be sold. In the event the Fund is unable to sell its leases and secured loans during the liquidation period, the Fund is expected to continue to return capital to its partners as those leases and loans mature. All of the Fund’s leases and loans mature by the end of 2029. The Fund entered its liquidation period in October 2011. Contractually, the Fund will terminate on December 31, 2029, unless sooner dissolved or terminated as provided in the Limited Partnership Agreement.
Prior to entering the liquidation period, the Fund acquired diversified portfolios of equipment to finance to end users throughout the United States as well as the District of Columbia and Puerto Rico. The Fund also acquired existing portfolios of equipment subject to existing financings from other equipment finance companies, primarily an affiliate of its General Partner. The primary objective of the Fund is to generate regular cash distributions to its partners from its equipment finance portfolio over the life of the Fund.
As of December 31, 2013, in addition to its 1% general partnership interest, the General Partner also had invested $1.0 million for a 2.0% limited partnership interest in the Fund.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of the Fund and its wholly-owned subsidiaries, LEAF Fund II, LLC and LEAF II Receivables Funding, LLC. All intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
Preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include the allowance for credit losses, the estimated unguaranteed residual values of leased equipment, and the fair value of interest rate swaps. The Fund bases its estimates on historical experience and on various other assumptions that it believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
Restricted Cash
The Fund had restricted cash of $0 and $762,000 at December 31, 2013 and 2012, respectively. As the Fund’s outstanding debt with WestLB was paid off in full in November 2013, there was no requirement for restricted cash at December 31, 2013.
Concentration of Credit Risk
As of December 31, 2013, 22% and 13% of the Fund’s portfolio was located in California and Puerto Rico, respectively. No other state accounted for more than 10% of the Fund’s portfolio balance as of December 31, 2013. Also, as of December 31, 2013, 36%, 22%, and 14% of the Fund’s leases and loans were in the services, manufacturing, and agriculture/forestry/fishing types of business, respectively. No other type of business accounted for more than 10% of the Fund’s leases and loans as of December 31, 2013. In addition, 13% of the Fund’s leases and loans were with the Puerto Rico Equipment and Hardware Company. No other individual end user accounted for more than 10% of the Fund’s leases and loans as of December 31, 2013.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements - (Continued)
December 31, 2013 and 2012
Investments in Leases and Loans
The Fund’s investments in leases and loans consist of direct financing leases, operating leases and loans.
Direct Financing Leases. Certain of the Fund’s lease transactions are accounted for as direct financing leases (as distinguished from operating leases). Such leases transfer substantially all benefits and risks of equipment ownership to the customer. The Fund’s investment in direct financing leases consists of the sum of the total future minimum lease payments receivable plus the estimated unguaranteed residual value of leased equipment, less unearned finance income. Unearned finance income, which is recognized as revenue over the term of the financing by the effective interest method, represents the excess of the total future minimum lease payments plus the estimated unguaranteed residual value over the cost of the related equipment.
Unguaranteed residual value represents the estimated amount to be received at lease termination from lease extensions or ultimate disposition of the leased equipment. The estimates of residual values are based upon the General Partner’s history with regard to the realization of residuals, available industry data and the General Partner’s experience with respect to comparable equipment. The estimated residual values are recorded as a component of investments in leases. Residual values are reviewed periodically to determine if the current estimate of the equipment’s fair market value appears to be below its recorded estimate. If required, residual values are adjusted downward to reflect adjusted estimates of fair market values. Upward adjustments to residual values are not permitted.
Operating Leases. Leases not meeting any of the criteria to be classified as direct financing leases are deemed to be operating leases. Under the accounting for operating leases, the cost of the leased equipment, including acquisition fees associated with lease placements, is recorded as an asset and depreciated on a straight-line basis over the equipment’s estimated useful life, generally up to seven years. Rental income consists primarily of monthly periodic rental payments due under the terms of the leases. The Fund recognizes rental income on a straight line basis.
A review for impairment of operating leases is performed whenever events or changes in circumstances indicate that the carrying amount of the operating leases may not be recoverable. The Fund writes down its rental equipment to its estimated net realizable value when it is probable that its carrying amount exceeds its fair value and the excess can be reasonably estimated; gains are only recognized upon actual sale of the rental equipment.
Loans. For term loans, the investment in loans consists of the sum of the total future minimum loan payments receivable less unearned finance income. Unearned finance income, which is recognized as revenue over the term of the financing by the effective interest method, represents the excess of the total future minimum contracted loan payments over the cost of the related equipment. For all other loans, interest income is recorded at the stated rate on the accrual basis to the extent that such amounts are expected to be collected.
Allowance for credit losses. The Fund evaluates the adequacy of the allowance for credit losses (including investments in leases and loans) based upon, among other factors, management’s historical experience on the portfolios it manages, an analysis of contractual delinquencies, economic conditions and trends, and equipment finance portfolio characteristics, adjusted for expected recoveries. In evaluating historic performance, the Fund performs a migration analysis, which estimates the likelihood that an account will progress through delinquency stages to ultimate charge-off. After an account becomes 180 or more days past due, any remaining balance is fully-reserved less an estimated recovery amount. Generally, past due accounts are referred to the Fund internal recovery group consisting of a team of credit specialists and collectors. The group utilizes several resources in an attempt to maximize recoveries on charged-off accounts including: 1) initiating litigation against the end user customer and any personal guarantor, 2) referring the account to an outside law firm or collection agency and/or 3) repossessing and remarketing the equipment through third parties. The Fund’s policy is to charge off to the allowance those financings which are in default and for which it is probable management will be unable to collect all amounts contractually owed. Income is not recognized on leases and loans when a default on monthly payment exists for a period of 90 days or more. Generally, income recognition resumes when a lease or loan becomes less than 90 days delinquent. Fees from delinquent payments are recognized when received and are included in other income.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements - (Continued)
December 31, 2013 and 2012
Transfers of Financial Assets
In connection with establishing its credit facilities with its banks, the Fund formed bankruptcy remote special purpose entities through which the financings are arranged. The Fund’s transfers of assets to the special purpose entities do not qualify for sales accounting treatment due to certain call provisions that the Fund maintains. Accordingly, assets and related debt of the special purpose entities are included in the Fund’s consolidated balance sheets. The Fund’s leases and restricted cash are assigned as collateral for these borrowings and there is no further recourse to the general credit of the Fund. Collateral in excess of these borrowings represents the Fund’s maximum loss exposure.
The Fund may sell leases to third parties. Leases are accounted for as sold when control of the lease is surrendered. Control over the leases are deemed surrendered when (1) the leases have been isolated from the Fund, (2) the buyer has the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the leases and (3) the Fund does not maintain effective control over the leases through either (a) an agreement that entitles and obligates the Fund to repurchase or redeem the leases before maturity, or (b) the ability to unilaterally cause the buyer to return specific leases. In connection with these sales, the Fund’s General Partner, the servicer of the leases prior to the sale, may continue to service the leases for the third party in exchange for “adequate compensation” as defined under U.S. GAAP. The Fund accrues liabilities for obligations associated with leases and loans sold which the Fund may be required to repurchase due to breaches of representations and warranties and early payment defaults. The Fund periodically evaluates the estimates used in calculating expected losses and adjustments are reported in earnings. To obtain fair values, the Fund generally estimates fair value based on the present value of future cash flows estimated using management’s best estimates of key assumptions, including credit losses and discount rates commensurate with the risks involved. As these estimates are influenced by factors outside the Fund’s control and as uncertainty is inherent in these estimates, actual amounts charged off could differ from amounts recorded. The provision for repurchases is recorded as a component of gain on sales of leases and loans.
Derivative Instruments
The Fund enters into derivative contracts, including interest rate swaps, to add stability to its financing costs and to manage its exposure to interest rate movements on its variable rate debt. U.S. GAAP requires recognition of all derivatives at fair value as either assets or liabilities on the balance sheet. The accounting for subsequent changes in the fair value of these derivatives is dependent on whether the derivative qualifies and has been designated for hedge accounting treatment pursuant to U.S. GAAP.
Changes in the fair value of derivative instruments are recognized immediately on the accompanying consolidated statement of operations. The Fund will continue to use derivative financial instruments to reduce exposure to changing interest rates, and accordingly, this may create volatility in the Fund’s results of operations due to subsequent changes in the fair value of Fund’s derivatives. All mark to market changes on derivatives are included in loss in derivative activities on the accompanying statement of operations.
Effective October 2010, the Fund discontinued the use of hedge accounting, which recognized changes in the fair value of derivative instruments in accumulated other comprehensive loss to the extent that they were effective at offsetting changes in the value of forecasted transactions that were designated as cash flow hedges. For any forecasted transactions that are probable of occurring, of which there were none as of December 31, 2013, the derivative loss remaining in accumulated other comprehensive loss is reclassified into earnings over the terms of the related forecasted borrowings. In the event that the forecasted borrowing is no longer probable of occurring, the related gain or loss in accumulated other comprehensive loss will be recognized in earnings immediately, which occurred in November 2013 when the Portigon term loan was paid off and related swap was terminated.
Income Taxes
Federal and state income tax laws provide that the income or losses of the Fund are reportable by the Partners on their individual income tax returns. Accordingly, no provision for such taxes has been made in the accompanying financial statements.
Comprehensive Loss
Comprehensive loss includes net loss and all other changes in the equity of a business during a period from transactions and other events and circumstances from non-owner sources. These changes, other than net loss, are referred to as “other comprehensive loss” and for the Fund only includes changes in accumulated other comprehensive loss resulting from the amortization of hedging activities that were previously designated as cash flow hedges and accounted for using hedge accounting, as noted above.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements - (Continued)
December 31, 2013 and 2012
Allocation of Partnership Income, Loss, and Cash Distributions and Net Loss Per Limited Partner Unit
The Fund allocates net income, net loss, and cash distributions as follows: 99% to the limited partners and 1% to the general partner.
Net loss per limited partner unit is computed by dividing net loss allocated to limited partners by the weighted average number of limited partner units outstanding during the period. The weighted average number of limited partner units outstanding during the period is computed based on the number of limited partner units issued during the period weighted for the days outstanding during the period.
Other Income
Other income includes miscellaneous fees charged by the Fund, such as late fee income, among others. The Fund recognizes late fee income as fees are collected. Late fee income was $175,000 for the year ended December 31, 2013 and $439,000 for the year ended December, 2012.
Recent Accounting Standards
Accounting Standards Recently Adopted
In April 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-07, Presentation of Financial Statements (Topic 205): Liquidation Basis of Accounting (ASU 2013-07 or the Update). The Update provides clarification and guidance regarding:
•
When an entity should apply the liquidation basis of accounting,
•
The recognition and measurement of assets and liabilities, and
•
Financial statement presentation and disclosure requirements.
Entities with a limited life (i.e., certain partnerships) are expected to liquidate at a specified time and in an orderly manner as disclosed in their governing documents. If a limited life fund ceases its operations and liquidates its assets and liabilities in accordance with its original plan for liquidation, the entity is not required to adopt the liquidation basis of accounting in accordance with the Update. While the Update is effective for entities with annual reporting periods beginning after December 15, 2013 (and interim periods therein), the Fund has early adopted the Update in 2013 with no impact to the financial statements.
NOTE 3 - INVESTMENT IN LEASES AND LOANS
The Fund’s investment in leases and loans, net, consists of the following (in thousands):
(a) The Fund’s direct financing leases are for initial lease terms generally ranging from 24 to 132 months.
(b) The interest rates on loans generally range from 5% to 17%.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements - (Continued)
December 31, 2013 and 2012
The components of direct financing leases and loans are as follows (in thousands):
(a) Unguaranteed residuals for direct financing leases represent the estimated amounts recoverable at lease termination from lease extensions or disposition of the equipment.
The Fund’s investment in operating leases, net, consists of the following (in thousands):
At December 31, 2013 the future minimum lease and loan payments and related rental payments scheduled to be received on non-cancelable direct financing leases, loans, and operating leases for each of the five succeeding annual periods ending December 31 and thereafter are as follows (in thousands):
(a) Operating lease amounts as shown are net of the residual value, if any, at the end of the lease term.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements - (Continued)
December 31, 2013 and 2012
NOTE 4 - ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY
The following table is an age analysis of the Fund’s receivables from leases and loans (presented gross of an allowance for credit losses of $370,000 and $680,000 as of December 31, 2013 and 2012, respectively) (in thousands):
(a)
Balances in this age category are collectively evaluated for impairment.
The Fund had $420,000 and $1.1 million of leases and loans on nonaccrual status as of December 31, 2013 and 2012, respectively. The credit quality of the Fund’s investment in leases and loans as of December 31, 2013 and 2012 is as follows (in thousands):
The following table summarizes the annual activity in the allowance for credit losses (in thousands):
(a) End of period balances are collectively evaluated for impairment.
NOTE 5 - DEFERRED FINANCING COSTS
As of December 31, 2013 and 2012, deferred financing costs include $8,000 and $521,000 respectively, of unamortized deferred financing costs which are being amortized over the life of the related debt. As the Portigon term loan matured in December 2013, and as the related party note was set to mature in February 2014, before it was extended in December 2013 through February 2015, all deferred financing costs were fully amortized as of February 28, 2014. Accumulated amortization as of December 31, 2013 and 2012 was $3.7 million and $3.1 million, respectively.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements - (Continued)
December 31, 2013 and 2012
NOTE 6 - DEBT AND NOTE PAYABLE TO RELATED PARTY
The Fund’s debt consists of the following (in thousands):
(1) This term loan was collateralized by specific lease receivables and related equipment. Interest on originations financed prior to March 2009 was calculated at London Interbank Offered Rate (“LIBOR”) plus 1.20% per year. Interest on originations financed after March 2009 was at a rate of LIBOR plus 2.50% per year.
(2) To mitigate fluctuations in interest rates, the Fund entered into interest rate swap agreements. The interest rate swap agreements terminate on various dates and fix the interest rate. These swaps were terminated in November 2013 in correlation with the pay down of the Portigon debt.
Weighted average borrowings for the year ended December 31, 2013 were $2.2 million as compared to $21.6 million for the year ended December 31, 2012, at effective interest rates of 36% and 11%, respectively.
Note payable to related party: The Fund owed Resource Capital Corporation, Inc. (“RSO”), which is a related entity of the Fund through common management with RAI, $5.7 million and $6.8 million as of December 31, 2013 and December 31, 2012, respectively. In June 2011, we paid a 1% fee to extend the note maturity date from March 2011 to February 2012 and to reduce the interest rate from 12% to 10% per annum. In February 2012 and January 2013, we incurred additional 1% fees of the outstanding principal amount each period that was paid to RSO to further extend the maturity date of the related party note payable in one-year increments from February 2012 to February 2014. In December 2013, without any additional fees, we extended the maturity date of the related party note payable from February 2014 to February 2015. Interest payments on the note payable were $624,000 and $775,000 for the years ended December 31, 2013 and 2012, respectively.
Repayments: Estimated annual principal payments on the Fund’s aggregate borrowings for future years ended December 31 are as follows (in thousands):
NOTE 7 - DERIVATIVE INSTRUMENTS
Since the Fund’s assets are structured on a fixed-rate basis, and funds borrowed through bank debt were obtained on a floating-rate basis, the Fund was exposed to interest rate risk if rates rose because it would have increased the Fund’s borrowing costs. To manage interest rate risk, the Fund employed a hedging strategy using derivative financial instruments such as interest rate swaps. The Fund does not use derivative financial instruments for trading or speculative purposes. The Fund manages the credit risk of possible counterparty default in these derivative transactions by dealing primarily with counterparties with investment grade ratings. The Fund has agreements with certain of its derivative counterparties that contain a provision where if the Fund defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Fund could also be declared in default on its derivative obligations. As of December 31, 2013, the Fund had not posted any collateral related to these agreements because the swaps were terminated in November 2013 in correlation with the pay down of the Portigon debt.
In July 2012, the Fund prospectively revised its estimate on amortization of accumulated other comprehensive losses which accelerated amortization and more closely aligned the recognition of accumulated other comprehensive loss with projected repayments of the Fund’s borrowings. This increased the Fund’s net loss and loss on derivatives by $408,000 and the net loss per limited partner unit by $0.67 per unit for the year ended December 31, 2012. The derivative loss remaining in accumulated other comprehensive loss at the end of 2012 was reclassified into earnings over the remaining term of the Portigon term loan. As the loan was paid off in November 2013, the balance in accumulated other comprehensive loss was zero as of December 31, 2013.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements - (Continued)
December 31, 2013 and 2012
The following tables present the fair value of the Fund’s derivative financial instruments, as well as their classification on the consolidated balance sheet as of December 31, 2012, and on the consolidated statement of operations for the year ended December 31, 2012 (dollars in thousands):
The following table indicates the fair value of the derivative contracts as of December 31, 2012 (in thousands):
The following table summarizes the effect of the interest rate swaps on the consolidated statements of operations and other comprehensive loss for the years ended December 31, 2013 and 2012 (in thousands):
(a) Losses reclassified from accumulated other comprehensive loss were recognized in loss on derivative activities on the accompanying statement of operations.
(b) Changes in fair value are recognized in loss on derivative activities and all cash payments on derivatives are recognized in interest expense. The Fund recognized expense of $223,000 and $636,000 in interest expense in 2013 and 2012, respectively, related to cash payments on derivatives. Changes in fair value of $217,000 and $556,000 were recognized as a reduction to expense within loss on derivative activities in 2013 and 2012, respectively.
NOTE 8 - FAIR VALUE MEASUREMENT
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal or most advantageous market for the asset or liability at the measurement date (exit price). U.S. GAAP establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (level 1) and the lowest priority to unobservable inputs (level 3). The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the measurement in its entirety.
• Level 1 - Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.
• Level 2 - Observable inputs other than quoted prices included within Level 1, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets.
• Level 3 - Unobservable inputs that reflect the entity’s own assumptions about the assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements - (Continued)
December 31, 2013 and 2012
The Fund employed a hedging strategy to manage exposure to the effects of changes in market interest rates. All derivatives were recorded on the consolidated balance sheets at their fair value as either assets or liabilities. Because the Fund’s derivatives were not listed on an exchange, these instruments were valued by a third-party pricing agent using an income approach and utilizing models that use as their primary basis readily observable market parameters. This valuation process considered factors including interest rate yield curves, time value, credit factors and volatility factors. Although the Fund had determined that the majority of the inputs used to value its derivatives fell within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilized Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, the Fund had assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and had determined that the credit valuation adjustments were not significant to the overall valuation of its derivatives. As a result, the Fund had determined that its derivative valuations in their entirety were classified in Level 2 of the fair value hierarchy.
Assets (liabilities) measured at fair value on a recurring basis included the following (in thousands):
The Fund is also required to disclose the fair value of financial instruments not measured at fair value for which it is practicable to estimate that value. For cash, restricted cash, receivables, and payables, the carrying amounts approximate fair value because of the short term maturity of these instruments.
The methods used to estimate the fair value on financial instruments that are not measured at fair value, the level within the fair value hierarchy that those fair value measurements are categorized, and the carrying value of the Fund’s debt at December 31, 2013 is as follows:
The fair value of the related party note payable was determined to approximate carrying value as the interest rate is comparable to current market rates.
NOTE 9 - CERTAIN RELATIONSHIPS AND TRANSACTIONS WITH AFFILIATES
The Fund relies on the General Partner and its affiliates to manage the Fund’s operations and pays the General Partner or its affiliates fees to manage the Fund in accordance with the Partnership Agreement. The following is a summary of fees and costs of services and materials charged by the General Partner or its affiliates (in thousands):
Acquisition Fees: The General Partner is paid a fee for assisting the Fund in acquiring equipment subject to existing equipment leases equal to 2% of the purchase price the Fund pays for the equipment or portfolio of equipment subject to existing equipment financing.
Management Fees: The General Partner has waived all future management fees. Approximately $220,000 and $581,000 of management fees were waived for the years ended December 31, 2013 and 2012, respectively, and approximately $4.2 million have been waived on a cumulative basis as of December 31, 2013.
Administrative Expenses: The General Partner and its affiliates are reimbursed by the Fund for administrative services reasonably necessary to operate the Fund which do not exceed the General Partner’s actual cost of those services.
Index
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements - (Continued)
December 31, 2013 and 2012
Due to Affiliates: Due to affiliates includes amounts due to the General Partner and its affiliates related to acquiring and managing portfolios of equipment from its General Partner, management fees and reimbursed expenses.
Distributions: The General Partner owns a 1% general partner interest and a 2% limited partner interest in the Fund. The General Partner was paid cash distributions of $11,000 and $22,000, respectively, for its general partner and limited partner interests in the Fund for the year ending December 31, 2013 and $12,000 and $24,000, respectively, for its general partner and limited partner interests in the Fund for the year ending December 31, 2012.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
The Fund is party to various legal proceeding arising out of the ordinary course of its business. Management believes that none of these actions, individually or in the aggregate, will have a material adverse effect on the Fund’s financial condition or results of operations.
NOTE 11 - SUBSEQUENT EVENTS
The Fund has evaluated its December 31, 2013 financial statements for subsequent events through the date the financial statements were issued. The Fund is not aware of any additional subsequent events which would require recognition or disclosure in the financial statements.
Index
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A
ITEM 9A - CONTROLS AND PROCEDURES
Disclosure Controls
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our periodic reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and our chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Under the supervision of our General Partner’s chief executive officer and chief financial officer, we have carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, our General Partner’s chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective at the reasonable assurance level discussed above.
Management’s Report on Internal Control over Financial Reporting
Our General Partner’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our General Partner’s management assessed the effectiveness of our internal control over financial reporting as of December 31, 2013. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO, in the 1992 Internal Control - Integrated Framework. Based upon this assessment, our General Partner’s management concluded that, as of December 31, 2013, our internal control over financial reporting is effective.
This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during the three month period ended December 31, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B
ITEM 9B - OTHER INFORMATION
None.
Index
PART III
ITEM 10
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Our General Partner manages our activities. Although our limited partners have limited voting rights under our partnership agreement, they do not directly or indirectly participate in our management or operations or have actual or apparent authority to enter into contracts on our behalf or to otherwise bind us. Our General Partner will be liable, as General Partner, for all of our debts to the extent not paid, except to the extent that indebtedness or other obligations incurred by it are specifically with recourse only to our assets. Whenever possible, our General Partner intends to make any of our indebtedness or other obligations with recourse only to our assets.
As is commonly the case with limited partnerships, we do not directly employ any of the persons responsible for our management or operation. Rather, our General Partner’s personnel manage and operate our business. Officers of our General Partner may spend a substantial amount of time managing the business and affairs of our General Partner and its affiliates and may face a conflict regarding the allocation of their time between our business and affairs and their other business interests.
The following table sets forth information with respect to the directors and executive officers of our General Partner.
Crit S. DeMent was Chairman of the Board of Directors and Chief Executive Officer of LEAF Financial since November 2001 until December 14, 2011. Mr. DeMent also serves as Chairman of the Board of Directors and Chief Executive Officer of LEAF Asset Management since it was formed in August 2006, Chairman of the Board of Directors and Chief Executive Officer of LEAF Funding since March 2003, a Senior Vice President of Resource America since 2005 and Senior Vice President - Equipment Leasing of Resource Capital Corp. since March 2005. Beginning January 1, 2011, Mr. DeMent serves as the Chairman of the Board of Directors and Chief Executive Officer of LEAF Commercial Capital, Inc. Before that, he was President of Fidelity Leasing, Inc. and its successor, the Technology Finance Group of Citi-Capital Vendor Finance from 1998 to 2001. Mr. DeMent was Vice President of Marketing for Tokai Financial Services from 1987 through 1996. Mr. DeMent serves as the Chairman of the Board of Directors of the Equipment Leasing and Finance Association.
Robert K. Moskovitz has been Chief Financial Officer of LEAF Financial since February 2004, Treasurer of LEAF Financial from September 2004 until April 2009, and Assistant Secretary of LEAF Financial since June 2007. Mr. Moskovitz also serves as Chief Financial Officer, and Assistant Secretary of LEAF Asset Management since it was formed in August 2006 and Chief Financial Officer and a Director of LEAF Funding since May 2004. Beginning January 1, 2011, Mr. Moskovitz serves as the Chief Financial Officer of LEAF Commercial Capital, Inc. He has over twenty years of experience as the Chief Financial Officer of both publicly and privately owned companies. From 2002 to 2004, Mr. Moskovitz was an independent consultant on performance management initiatives, primarily to the financial services industry. From 2001 to 2002 he was Executive Vice President and Chief Financial Officer of ImpactRx, Inc., which provides advanced sales and marketing intelligence to pharmaceutical companies. From 1983 to 2001 Mr. Moskovitz held senior executive level financial positions with several high growth public and privately held companies. He began his professional career with Deloitte & Touche (formerly Touche Ross & Co). Mr. Moskovitz holds a B.S. degree in Business Administration from Drexel University.
Jonathan Z. Cohen has been a Director of LEAF Financial since January 2002 and a Director of LEAF Asset Management since it was formed in August 2006. Mr. Cohen also serves, or has served, in the following positions with Resource America: a Director since 2002, President since 2003, Chief Executive Officer since 2004, Chief Operating Officer from 2002 to 2004, Executive Vice President from 2001 to 2003, and Senior Vice President from 1999 to 2001. In addition, Mr. Cohen serves as Chief Executive Officer, President and a Director of Resource Capital Corp. (a publicly-traded real estate investment trust) since its formation in 2005. Mr. Cohen also serves as Vice Chairman of the Managing Board of Atlas Pipeline Partners GP, LLC (the general partner of Atlas Pipeline Partners, L.P., a publicly-traded oil and gas pipeline limited partnership) since its formation in 1999, Chairman of the Board of Directors of Atlas Energy GP, LLC (the general partner of Atlas Energy, L.P. (f/k/a Atlas Pipeline Holdings, L.P.), a publicly-traded oil and gas limited partnership) and Vice Chairman of the Board of Directors of Atlas Resource Partners GP, LLC (the general partner of Atlas Resource Partners, L.P., a publicly-traded oil and gas E&P limited partnership) since February 2012. Mr. Cohen was also Vice Chairman of the Board of Directors of Atlas Energy, Inc. ((f/k/a Atlas America, Inc.) a publicly-traded oil and gas company) from September 2000 until February 2011 and Vice Chairman of Atlas Energy Resources, LLC from June 2006 until February 2011.
Index
Jeffrey F. Brotman has been a Director of LEAF Financial since April 2008 and a Director of LEAF Asset Management since 2010. Mr. Brotman has also been Executive Vice President of Resource America since June 2007. Mr. Brotman was a co-founder of Ledgewood, P.C. (a Philadelphia-based law firm) and was affiliated with the firm from 1992 until June 2007, serving as its managing partner from 1995 until March 2006. Mr. Brotman is also a non-active Certified Public Accountant and an Adjunct Professor at the University of Pennsylvania Law School. Mr. Brotman was Chairman of the Board of Directors of TRM Corporation (a publicly-traded consumer services company) from September 2006 until September 2008 and was its President and Chief Executive Officer from March 2006 through June 2007.
Thomas C. Elliott has been a Director of LEAF Financial since June 2012. Mr. Elliott has also been the Chief Financial Officer of Resource America, Inc. since December 2009, Senior Vice President since 2005, Senior Vice President − Finance and Operations from 2006 to December 2009, Senior Vice President - Finance from 2005 to 2006, and Vice President - Finance from 2001 to 2005. Mr. Elliott has also been the Chief Financial Officer, Chief Accounting Officer, and Treasurer of Resource Capital Corp. from 2005 to 2006 and the Senior Vice President - Finance and Operations since 2006. From 1997 to 2001, Mr. Elliott held various financial positions at Fidelity Leasing, Inc., including Manager of Financial Planning, Director of Asset Securitization, and Treasurer.
Jeffrey D. Blomstrom has been a Director of LEAF Financial since June 2012. Mr. Blomstrom has also been the President and Managing Director of Resource Financial Fund Management, Inc. (a wholly-owned asset management subsidiary of Resource America Inc.) since 2003, Senior Vice President - CDO Structuring of Resource Capital Corp. since 2005, Managing Director at Cohen and Company (a Philadelphia-based investment bank specializing in the financial services sector) from 2001 to 2003, Senior Vice President of iATMglobal.net (an ATM software development company) from 2000 to 2001, and an Attorney at Covington & Burling (an international law firm) from 1999 to 2000.
The board of directors of our General Partner has not adopted specific minimum qualifications for service on the board, but rather seeks a mixture of skills that are relevant to our business. The following presents a brief summary of the attributes of each director that led to the conclusion that such person should serve as a director:
Mr. Cohen has extensive financial and operational experience, including as the chief executive officer of our general partner’s publicly traded parent company.
Mr. Brotman has extensive experience in finance, law, and as the chief executive officer of a public company.
Mr. Elliott has extensive financial and operational experience, including as the chief financial officer of our general partner’s publically-traded parent company.
Mr. Blomstrom has extensive experience in finance, law, and as a president and managing director of several companies.
Code of Business Conduct and Ethics
Because we do not directly employ any persons, we rely on a Code of Business Conduct and Ethics adopted by Resource America, Inc. that applies to the principal executive officer and principal financial officer of our General Partner, as well as to persons performing services for us generally. You may obtain a copy of this code of ethics by a request to our General Partner at LEAF Financial Corporation, One Commerce Square, 2005 Market Street, 14th Floor, Philadelphia, Pennsylvania 19103.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, which we refer to as the Exchange Act, requires the directors and executive officers of our General Partner, our General Partners, and holders greater than 10% of our limited partnership interests to file reports with the SEC. SEC regulations require us to identify anyone who filed a required report late during the most recent fiscal year. Based on our review of these reports, we believe that the filing requirements for all of these reporting persons were complied with during 2013.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
We do not have, nor do we expect to have, any employees as discussed in Item 10 - “Directors and Executive Officers of the Registrant.” Instead, our management and day-to-day activities are provided by the employees of our General Partner and its affiliates. No officer or director of our General Partner will receive any direct remuneration from us. Those persons will receive compensation solely from our General Partner or its affiliates other than us.
Index
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED UNIT HOLDER MATTERS
(a) We had 1,419 limited partners as of December 31, 2013.
(b) In 2004, our General Partner contributed $1,000 to our capital as our General Partner and received its General Partner interest in us. As of December 31, 2013 our General Partner owned 11,986 of our limited partner units. These purchases of limited partner units by our General Partner and its affiliates were at a price discounted by the 7% sales commission which was paid by most of our other limited partners.
(c) We know of no arrangements that would, at any date subsequent to the date of this report, result in a change in control of us.
(d) Our General Partner’s name and address is LEAF Financial Corporation, One Commerce Square, 2005 Market Street, 14th Floor, Philadelphia, Pennsylvania 19103.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We do not directly employ any persons to manage or operate our business. These functions are provided by our General Partner and employees of our General Partner and/or its affiliates. We reimburse our General Partner and/or its affiliates for all direct and indirect costs of services provided, including the cost of employees and benefits properly allocable to us and all other expenses necessary or appropriate for the conduct of our business. The following is a summary of fees and costs of services charged by our General Partner or its affiliates (in thousands):
Acquisition Fees: Our General Partner was paid a fee for assisting us in acquiring equipment subject to existing equipment leases equal to 2% of the purchase price we paid for the equipment or portfolio of equipment subject to existing equipment financing.
Management Fees: Our General Partner has waived all future management fees. Approximately $220,000 of management fees were waived for the year ended December 31, 2013 and approximately $4.2 million have been waived on a cumulative basis.
Administrative Expenses: Our General Partner and its affiliates are reimbursed by us for administrative services reasonably necessary to operate which don’t exceed our General Partner’s cost of those fees or services.
Due to Affiliates: Due to affiliates includes amounts due to our General Partner related to acquiring and managing portfolios of equipment from our General Partner, management fees and reimbursed expenses.
Note payable to related party: We owed Resource Capital Corporation, Inc. (“RSO”), which is a related entity of the Fund through common management with RAI, $5.7 million and $6.8 million as of December 31, 2013 and December 31, 2012, respectively. In June 2011, we paid a 1% fee to extend the note maturity date from March 2011 to February 2012 and to reduce the interest rate from 12% to 10% per annum. In February 2012 and January 2013, we incurred additional 1% fees of the outstanding principal amount each period that was paid to RSO to further extend the maturity date of the related party note payable in one-year increments from February 2012 to February 2014. In December 2013, without any additional fees, we extended the maturity date of the related party note payable from February 2014 to February 2015. Interest payments on the note payable were $624,000 and $775,000 for the years ended December 31, 2013 and 2012, respectively.
Distributions. Our General Partner owns a 1% general partner interest and a 2.0% limited partner interest in us. Our General Partner was paid cash distributions of $11,000 and $22,000 respectively, for its general partner and limited partner interests in us for the year ending December 31, 2013 and $12,000 and $24,000 respectively, for its general partner and limited partner interests in us for the year ending December 31, 2012.
Because we are not listed on any national securities exchange or inter-dealer quotation system, we have elected to use the Nasdaq National Stock Market’s definition of “independent director” in evaluating whether any of our General Partner’s directors are independent. Under this definition, the board of directors of our General Partner has determined that Linda Richardson is an independent Director of our General Partner.
Index
ITEM 14
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees. The aggregate fees billed by our independent auditors, Grant Thornton, LLP related to quarterly reviews and the year-end audit were approximately $117,000 and $115,000 for the years ended December 31, 2013 and 2012, respectively.
Audit-Related Fees. We did not incur fees in 2013 and 2012 for other services not included above.
Tax Fees. We did not incur fees in 2013 and 2012 for other services not included above.
All Other Fees. Our auditors, Grant Thornton, LLP, billed us for professional services rendered related to sales tax filings of approximately $23,000 for each of the years ended December 31, 2013 and 2012.
Procedures for Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditor.
Our General Partner’s Board of Directors reviews and approves in advance any audit and any permissible non-audit engagement or relationship between us and our independent auditors.
Index
PART IV
ITEM 15
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this Annual Report on Form 10-K:
1. Financial Statements
The financial statements required by this Item are set forth in Item 8 - “Financial Statements and Supplementary Data.”
2. Financial Statement Schedules
No schedules are required to be presented in this report under Regulation S-X promulgated by the SEC.
3. Exhibits
Index
(1) Filed previously on June 17, 2004 as an exhibit to our Registration Statement and by this reference incorporated herein.
(2) Filed previously on September 7, 2004 in Pre-Effective Amendment No. 1 as an exhibit to our Registration Statement and by this reference incorporated herein.
(3) Filed previously as an exhibit to our Form 10-Q for the quarter ended June 30, 2005 and by this reference incorporated herein.
(4) Filed previously on December 27, 2005 as Appendix A Post-Effective Amendment No. 1 to our Registration Statement and by this reference incorporated herein.
(5) Filed previously as an exhibit to our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 and by this reference incorporated herein.
(6) Filed previously as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 and by this reference incorporated herein.
(7) Filed previously as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2007 and by this reference incorporated herein.
(8) Filed previously as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2008 and by this reference incorporated herein.
(9) Filed previously as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2008 and by this reference incorporated herein.
(10) Filed previously as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2009 and by this reference incorporated herein.
(11) Filed previously as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 and by this reference incorporated herein.
(12) Filed previously as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2009 and by this reference incorporated herein.
(13) Filed previously as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 and by this reference incorporated herein.
Index
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ CRIT S. DEMENT
Chief Executive Officer of the General Partner
March 31, 2014
Crit S. Dement
(Principal Executive Officer)
/s/ ROBERT K. MOSKOVITZ
Chief Financial Officer
March 31, 2014
Robert K. Moskovitz
(Principal Accounting and Financial Officer)
/s/ JONATHAN Z. COHEN
Director of the General Partner
March 31, 2014
Jonathan Z. Cohen
/s/ JEFFREY F. BROTMAN
Director of the General Partner
March 31, 2014
Jeffrey F. Brotman
/s/ THOMAS C. ELLIOTT
Director of the General Partner
March 31, 2014
Thomas C. Elliott
/s/ JEFFREY D. BLOMSTROM
Director of the General Partner
March 31, 2014
Jeffrey D. Blomstrom