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EXCEL - IDEA: XBRL DOCUMENT - Lease Equity Appreciation Fund II, L.P.Financial_Report.xls
EX-32.2 - EXHIBIT 32.2 - Lease Equity Appreciation Fund II, L.P.ex32_2.htm
EX-31.2 - EXHIBIT 31.2 - Lease Equity Appreciation Fund II, L.P.ex31_2.htm
EX-32.1 - EXHIBIT 32.1 - Lease Equity Appreciation Fund II, L.P.ex32_1.htm
EX-31.1 - EXHIBIT 31.1 - Lease Equity Appreciation Fund II, L.P.ex31_1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
 

FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from   to  
 
Commission file number 333-116595


 
LEASE EQUITY APPRECIATION FUND II, L.P.
(Exact name of registrant as specified in its charter)
Delaware
 
20-1056194
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 

 
110 South Poplar Street, Suite 101, Wilmington Delaware 19801
(Address of principal executive offices) (Zip Code)
 
(800) 819-5556
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. xYes     ¨ No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x  Yes     ¨  No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
¨
Accelerated filer
¨
       
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller Reporting Company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    ¨ Yes    x No
 
There is no public market for the Registrant’s securities.
 


 
 

 
 
LEASE EQUITY APPRECIATION FUND II, L.P.
ON FORM 10-Q
 
   
PAGE
PART I
FINANCIAL INFORMATION
 
ITEM 1.
3
  3
  4
  5
  6
  7
  8
ITEM 2.
18
ITEM 3.
24
ITEM 4.
25
     
PART II
OTHER INFORMATION
 
ITEM 6.
26
     
28
 
 
2

 
PART1. FINANCIAL INFORMATION
 
 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
(In thousands)

   
September 30,
       
   
2012
   
December 31,
 
   
(Unaudited)
   
2011
 
ASSETS
           
Cash
  $ 384     $ 21  
Restricted cash
    755       13,056  
Investment in leases and loans, net
    19,140       39,451  
Deferred financing costs, net
    835       1,302  
Other assets
    6       132  
Total assets
  $ 21,120     $ 53,962  
                 
LIABILITIES AND PARTNERS’ DEFICIT
               
Liabilities:
               
Debt
  $ 9,828     $ 37,906  
Note payable - related party
    7,439       7,820  
Accounts payable and accrued expenses
    366       438  
Other liabilities
    328       368  
Derivative liabilities, at fair value
    318       773  
Due to affiliates
    16,739       17,149  
Total liabilities
    35,018       64,454  
                 
Commitments and contingencies (Note 10)
               
                 
Partners’ Deficit:
               
General partner
    (642 )     (605 )
Limited partners
    (12,348 )     (8,631 )
Accumulated other comprehensive loss
    (908 )     (1,256 )
Total partners’ deficit
    (13,898 )     (10,492 )
Total liabilities and partners' deficit
  $ 21,120     $ 53,962  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
3

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
 (In thousands, except unit data)
(Unaudited)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Revenues:
                       
Interest on equipment financings
  $ 543     $ 1,006     $ 2,076     $ 4,067  
Rental income
    31       176       115       668  
Gains/(losses) on sale of equipment and lease dispositions, net
    53       (18 )     122       (288 )
Other income
    99       134       418       601  
      726       1,298       2,731       5,048  
                                 
Expenses:
                               
Interest expense
    633       764       1,741       2,547  
Interest expense - related party
    197       203       592       672  
Depreciation on operating leases
    17       133       77       481  
Provision for credit losses
    1,112       504       2,238       3,635  
General and administrative expenses
    104       229       635       806  
Administrative expenses reimbursed to affiliate
    59       168       223       535  
Loss on derivative activities
    15       57       76       232  
      2,137       2,058       5,582       8,908  
Net loss
  $ (1,411 )   $ (760 )   $ (2,851 )   $ (3,860 )
Net loss allocated to limited partners
  $ (1,397 )   $ (752 )   $ (2,822 )   $ (3,821 )
                                 
Weighted average number of limited partner units outstanding during the period
    592,809       592,809       592,809       592,809  
Net loss per weighted average limited partner unit
  $ (2.36 )   $ (1.27 )   $ (4.76 )   $ (6.45 )

The accompanying notes are an integral part of these consolidated financial statements.

 
4


LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
(In thousands)
(Unaudited)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Net loss
  $ (1,411 )   $ (760 )   $ (2,851 )   $ (3,860 )
Amortization of net loss on financial derivatives reclassified from accumulated other comprehensive loss
    178       159       348       476  
Comprehensive loss
  $ (1,233 )   $ (601 )   $ (2,503 )   $ (3,384 )

The accompanying notes are an integral part of these consolidated financial statements.
 
 
5

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
(In thousands, except unit data)
(Unaudited)

               
Accumulated
       
   
General
         
Other
   
Total
 
   
Partner
   
Limited Partners
   
Comprehensive
   
Partners’
 
   
Amount
   
Units
   
Amount
   
(Loss) Income
   
Deficit
 
                               
Balance, January 1, 2012
  $ (605 )     592,809     $ (8,631 )   $ (1,256 )   $ (10,492 )
Cash distributions
    (8 )     -       (895 )     -       (903 )
Net loss
    (29 )     -       (2,822 )     -       (2,851 )
Amortization of net loss on financial derivatives
    -       -       -       348       348  
Balance, September 30, 2012
  $ (642 )     592,809     $ (12,348 )   $ (908 )   $ (13,898 )

The accompanying notes are an integral part of this consolidated financial statement.
 
 
6

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
(In thousands)
(Unaudited)

   
Nine Months Ended
September 30,
 
   
2012
   
2011
 
Cash flows from operating activities:
           
Net loss
  $ (2,851 )   $ (3,860 )
Adjustments to reconcile net loss to net cash (used in) provided by operating  activities:
               
(Gains)/losses on sale of equipment and lease dispositions, net
    (122 )     288  
Depreciation on operating leases
    77       481  
Provision for credit losses
    2,238       3,635  
Amortization of deferred financing costs
    735       802  
Net loss/(gain) on derivative activities
    422       (802 )
Changes in operating assets and liabilities:
               
Other assets
    126       153  
Accounts payable and accrued expenses, and other liabilities
    (691 )     (35 )
Due to affiliates
    (410 )     (74 )
Net cash (used in) provided by operating activities
    (476 )     588  
                 
Cash flows from investing activities:
               
Proceeds from leases and loans
    18,573       33,983  
Security deposits returned
    (455 )     (133 )
Net cash provided by investing activities
    18,118       33,850  
                 
Cash flows from financing activities:
               
Repayment of debt
    (28,078 )     (36,475 )
Repayments - note payable - related party
    (458 )     (99 )
Decrease in restricted cash
    12,301       2,905  
Increase in deferred financing costs
    (141 )     (80 )
Cash distributions to partners
    (903 )     (899 )
Net cash used in financing activities
    (17,279 )     (34,648 )
                 
Increase (decrease) in cash
    363       (210 )
Cash, beginning of period
    21       239  
Cash, end of period
  $ 384     $ 29  
                 
Supplemental cash flow disclosure:
               
Cash paid for interest
  $ 1,288     $ 1,958  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
7

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
September 30, 2012
(Unaudited)
 
NOTE 1 – ORGANIZATION AND NATURE OF BUSINESS
 
Lease Equity Appreciation Fund II, L.P. (“LEAF II” or 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 (“the 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 September 30, 2012, 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.
 
The accompanying unaudited financial statements reflect all adjustments that are, in the opinion of management, of a normal and recurring nature and necessary for a fair statement of the Fund’s financial position as of September 30, 2012, and the results of its operations and cash flows for the periods presented. The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of results of the Fund’s operations for the 2012 calendar year. The financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for interim financial reporting.  Accordingly, certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted pursuant to those rules and regulations. These interim financial statements should be read in conjunction with the Fund’s financial statements and notes thereto presented in the Fund’s Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC on March 28, 2012.
 
The Fund has evaluated subsequent events through the date the financial statements were issued and determined there were no events that have occurred that would require adjustments to the consolidated financial statements.
 
Reclassification
 
Certain reclassifications have been made to 2011 reported amounts to conform to the current year presentation. Amortization of other comprehensive loss on the Fund’s interest rate swaps of approximately $159,000 and $476,000 for the three and nine months ended September 30, 2011, respectively, was reclassified from loss on derivative activities to interest expense.
 
Use of Estimates
 
Preparation of financial statements in conformity with 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.
 
 
8

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements – (Continued)
September 30, 2012
(Unaudited)
 
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.  The Fund’s 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. 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.

Derivative Instruments

The Fund recognizes all derivatives at fair value as either assets or liabilities in the consolidated balance sheets. The accounting for subsequent changes in the fair value of these derivatives depended on whether the derivative had been designated and qualified for hedge accounting treatment pursuant to U. S. GAAP.

Prior to October 1, 2010, the Fund entered into derivative contracts, including interest rate swaps, substantially all of which were accounted for as cash flow hedges.  Under hedge accounting, the effective portion of the overall gain or loss on a derivative designated as a cash flow hedge was reported in accumulated other comprehensive loss on the consolidated balance sheets and was then reclassified into earnings as an adjustment to interest expense over the term of the related borrowing.
 
 
9

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements – (Continued)
September 30, 2012
(Unaudited)
 
Effective October 1, 2010, the Fund discontinued the use of hedge accounting. Therefore, any subsequent changes in the fair value of derivative instruments, including those that had previously been accounted for under hedge accounting, and periodic settlements of contracts, are recognized immediately in the accompanying consolidated statements of operations. While the Fund will continue to use derivative financial instruments to reduce exposure to changing interest rates, this accounting change may create volatility in the Fund’s results of operations, as the fair value of the Fund’s derivative financial instruments change.
 
For the forecasted transactions that are probable of occurring, the derivative gain or loss remaining in accumulated other comprehensive loss as of  September 30, 2012 is being reclassified into earnings over the terms of the related forecasted borrowings, consistent with hedge accounting treatment. In the event that the related forecasted borrowing is no longer probable of occurring, the related gain or loss in accumulated other comprehensive loss will be recognized in earnings immediately.
 
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 $86,000 and $362,000, respectively, for the three and nine months ended September 30, 2012 and $133,000 and $506,000, respectively, for the three and nine months ended September 30, 2011.
 
Recent Accounting Standards

Accounting Standards Recently Adopted

Comprehensive Income - In June 2011, the FASB issued an amendment to eliminate the option to present components of other comprehensive income as part of the statement of changes in equity.  The amendment requires that all non-owner changes in equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. The Fund adopted the two-statement approach for the period beginning January 1, 2012.

Fair Value Measurements - In May 2011, the FASB issued an amendment to revise the wording used to describe the requirements for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the FASB does not intend for the amendments to result in a change in the application of the current requirements. Some of the amendments clarify the FASB’s intent about the application of existing fair value measurement requirements, such as specifying that the concepts of highest and best use and valuation premise in a fair value measurement are relevant only when measuring the fair value of nonfinancial assets. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements such as specifying that, in the absence of a Level 1 input, a reporting entity should apply premiums or discounts when market participants would do so when pricing the asset or liability. This guidance was adopted by the Fund for the period beginning January 1, 2012 and did not significantly impact the Fund’s consolidated financial statements.
 
 
10


LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements – (Continued)
September 30, 2012
(Unaudited)
 
NOTE 3 – INVESTMENT IN LEASES AND LOANS
 
The Fund’s investment in leases and loans, net, consists of the following (in thousands):
 
   
September 30,
   
December 31,
 
   
2012
   
2011
 
Direct financing leases (a)
  $ 11,695     $ 25,779  
Loans (b)
    7,971       14,154  
Operating leases
    84       278  
      19,750       40,211  
Allowance for credit losses
    (610 )     (760 )
    $ 19,140     $ 39,451  
 

(a)
The Fund’s direct financing leases are for initial lease terms generally ranging from 24 to 120 months.
(b)
The interest rates on loans generally range from 6% to 14%.
 
The components of direct financing leases and loans are as follows (in thousands):
 
   
September 30,
   
December 31,
 
   
2012
   
2011
 
   
Leases
   
Loans
   
Leases
   
Loans
 
Total future minimum lease payments
  $ 11,865     $ 8,993     $ 27,286     $ 16,030  
Unearned income
    (909 )     (942 )     (2,674 )     (1,765 )
Residuals, net of unearned residual income (a)
    933       -       1,767       -  
Security deposits
    (194 )     (80 )     (600 )     (111 )
    $ 11,695     $ 7,971     $ 25,779     $ 14,154  
 

(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):
 
   
September 30,
   
December 31,
 
   
2012
   
2011
 
Equipment
  $ 531     $ 1,428  
Accumulated depreciation
    (447 )     (1,149 )
Security deposits
    -       (1 )
    $ 84     $ 278  
 
 
11

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements – (Continued)
September 30, 2012
(Unaudited)
 
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 allowance for credit losses of $610,000 and $760,000) as of September 30, 2012 and December 31, 2011, respectively (in thousands):

   
September 30, 2012
   
December 31, 2011
 
Age of receivable
 
Investment in leases and loans
   
%
   
Investment in
leases and loans
   
%
 
Current
  $ 17,408       88.1 %   $ 37,692       93.7 %
Delinquent:
                               
31 to 91 days past due
    1,436       7.3 %     1,545       3.9 %
Greater than 91 days (a)
    906       4.6 %     974       2.4 %
    $ 19,750       100.0 %   $ 40,211       100.0 %
 

(a)
Balances in this age category are collectively evaluated for impairment.
 
The Fund had $906,000 and $974,000 of leases and loans on nonaccrual status as of September 30, 2012 and December 31, 2011, respectively.  The credit quality of the Fund’s investment in leases and loans as of September 30, 2012 is as follows (in thousands):

   
September 30,
 2012
   
December 31,
 2011
 
Performing
  $ 18,844     $ 39,237  
Nonperforming
    906       974  
    $ 19,750     $ 40,211  
 
The following table summarizes the activity in the allowance for credit losses (in thousands):

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Allowance for credit losses, beginning of period
  $ 780     $ 2,850     $ 760     $ 5,320  
Provision for credit losses
    1,112       504       2,238       3,635  
Charge-offs
    (1,491 )     (2,707 )     (2,954 )     (9,123 )
Recoveries
    209       583       566       1,398  
Allowance for credit losses, end of period (a)
  $ 610     $ 1,230     $ 610     $ 1,230  
 

(a)
End of period balances were collectively evaluated for impairment.

 
12

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements – (Continued)
September 30, 2012
(Unaudited)
 
NOTE 5 – DEFERRED FINANCING COSTS
 
As of September 30, 2012 and December 31, 2011, deferred financing costs include $835,000 and $1.3 million, respectively, of unamortized deferred financing costs which are being amortized over the terms of the estimated life of the related debt. Accumulated amortization as of September 30, 2012 and December 31, 2011 was $2.8 million and $4.7 million, respectively.
 
 NOTE 6 – DEBT AND NOTE PAYABLE TO RELATED PARTY
 
The Fund’s debt consists of the following (in thousands):
 
         
September 30, 2012
       
 
Type
 
Maturity Date
 
Amount Outstanding
   
Interest rate
per annum
per
agreement
   
Interest rate
per annum adjusted for Swaps
   
December 31, 2011 Outstanding Balance
 
WestLB, AG (1)
Term
 
December 2013
  $ 9,828         (1)     5.6 %   $ 24,962  
                                       
2007-1 Term Securitization - Class B
Term
 
March 2015
    -       6.7 %     6.7 %     12,944  
          $ 9,828                     $ 37,906  
 

(1)
This term loan is collateralized by specific lease receivables and related equipment. Interest on originations financed prior to March 2009 are calculated at London Interbank Offered Rate (“LIBOR”) plus 1.20% per year. Interest on originations financed after March 2009 are at a rate of LIBOR plus 2.50% per year. As of September 30, 2012, $12.6 million of leases and loans and $749,000 of restricted cash were pledged as collateral under this facility.

The Fund paid off the remaining balance of $8.7 million on the 2007-1 Term Securitization on August 20, 2012.
 
On April 7, 2011 the Fund was notified by WestLB AG, which later became known as Portigon Financial Services (“Portigon” or the “Lender”), that it was in default on its loan agreement due to various ongoing covenant breaches.  These breaches relate to the percentage of defaulted leases in its portfolio, the percentage of defaulted leases in the overall lease portfolio serviced by the General Partner, and a required minimum credit support amount, among others.  On June 29, 2012, the Fund amended its agreement with the Lender whereby the Lender waived its right to pursue any of its rights or remedies on the existing covenant breaches.  Additionally, the agreement was amended to remove certain covenants from the loan agreement. Accordingly, as of September 30, 2012 the Fund was in compliance with the term facility. In exchange for the foregoing, the Fund and the parent of the Fund’s General Partner have agreed to a limited guaranty of a portion of the remaining amount due to the Lender.  The Lender has further agreed to accept a discount on a payoff of the loan at its December 2013 maturity date in the event the natural runoff of the portfolio had not paid off the loan balance prior to such date.
 
Note payable related party:  The Fund owed Resource Capital Corporation, Inc. (“RSO”), which is a related entity of the Fund through common management with RAI, $7.4 million and $7.8 million as of September 30, 2012 and December 31, 2011, respectively. On June 3, 2011, the Fund paid a 1% fee to extend the note maturity date from March 4, 2011 to February 15, 2012 and to reduce the interest rate from 12% to 10% per year.  On February 15, 2012, the Fund incurred an additional 1% fee, or $77,000, to further extend the maturity of the note payable to February 15, 2013. Prior to the repayment of the 2007-1 Term Securitization, monthly payments were made at approximately 0.3% of the outstanding principal and interest payable quarterly.  Subsequent to the payoff of the 2007-1 Term Securitization the Fund began to apply cash receipts on leases and loans that had been pledged as collateral on the 2007-1 Term Securitization to repayment of the related party note payable.  Interest payments on the note payable were $592,000 and $672,000 for the nine month periods ended September 30, 2012 and 2011, respectively.
 
 
13

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements – (Continued)
September 30, 2012
(Unaudited)
 
Repayments:  Estimated annual principal payments on the Fund’s aggregate borrowings over the next three annual periods ended September 30 are as follows (in thousands):

September 30, 2013
  $ 8,863  
September 30, 2014
    4,060  
September 30, 2015
    4,344  
    $ 17,267  

NOTE 7 – DERIVATIVE INSTRUMENTS

Since the Fund’s assets are structured on a fixed-rate basis, and funds borrowed through bank debt are obtained on a floating-rate basis, the Fund is exposed to interest rate risk if rates rise because it will increase the Fund’s borrowing costs. To manage interest rate risk, the Fund employs 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 September 30, 2012, the Fund has not posted any collateral related to these agreements. If the Fund had breached any of these provisions at September 30, 2012, it could be required to settle its obligations under the agreements at their termination value of $338,000.
 
At September 30, 2012, the Fund has 20 interest rate swaps which terminate on various dates ranging from July 2013 to August 2015 which generally coincide with the maturity period of the portfolio of lease and loans.

For the forecasted transactions that are probable of occurring, the derivative loss remaining in accumulated other comprehensive loss as of September 30, 2012 is being reclassified into earnings over the terms of the related forecasted borrowings, consistent with hedge accounting treatment. In July 2012 the Fund prospectively revised its estimate on amortization of accumulated other comprehensive loss which will accelerate amortization and more closely align the recognition of accumulated other comprehensive loss with projected repayments of the Fund’s borrowings. This increased the Fund’s net loss and interest expense by $312,000 and the net loss per limited partner unit by $0.52 per share for the three and nine month periods ended September 30, 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  September 30, 2012 and December 31, 2011, and on the consolidated statement of operations for the nine months ended September 30, 2012 and 2011 (dollars in thousands):
 
   
2012
   
2011
 
Fixed swaps (notional amount)
  $ 11,663     $ 24,657  
Range of receive rate
    0.21% - 0.26 %     0.45% - 0.57 %
Range of pay rate
    3.03% - 5.55 %     3.03% - 5.55 %
 
The following table indicates the fair value of the derivative contracts as of September 30, 2012 and December 31, 2011(in thousands):

 
Balance Sheet Location
 
Derivative Assets
   
Derivative Liabilites
 
2012
Derivative liabilities, at fair value
  $ -     $ 318  
2011
Derivative liabilities, at fair value
  $ -     $ 773  

 
14

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements – (Continued)
September 30, 2012
(Unaudited)
 
The following table summarizes the effect of the interest rate swaps on the consolidated statements of operations and other comprehensive loss for the nine month periods ended September 30, 2012 and 2011 (in thousands):

 
Location of loss
reclassified from
OCI to the
statement of
operations
 
Amount of loss
reclassified from
OCI to the statement
of operations
 
Location of loss
recognized  in the
statement of
operations
 
Amount of loss
recognized in the
statement of
operations
 
2012
(a)
  $ 348  
(b)
  $ 76  
2011
(a)
  $ 476  
(b)
  $ 232  
 

 
(a)
Losses reclassified from accumulated other comprehensive loss were realized in interest expense on the accompanying statement of operations.
 
 
(b)
All changes in fair value of derivatives subsequent to dedesignation as cash flow hedges were realized in loss on derivative activities on the accompanying statement of operations.
 
As discussed in note 6, the Fund fully paid off the 2007-1 Term Securitization in August 2012.  In conjunction with the termination of this facility, the Fund recognized a gain of $282,000 in interest expense related to the write off of the remaining balance of accumulated other comprehensive income associated with interest rate swaps previously designated as cash flow hedges on this facility.
 
As of September 30, 2012, $908,000 of the unrealized loss remains in accumulated other comprehensive loss and approximately $759,000 is expected to be charged to earnings over the next 12 months.
 
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.
 
The Fund employs a hedging strategy to manage exposure to the effects of changes in market interest rates. All derivatives are recorded on the consolidated balance sheets at their fair value as either assets or liabilities. Because the Fund’s derivatives are not listed on an exchange, these instruments are 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 considers factors including interest rate yield curves, time value, credit factors and volatility factors. Although the Fund has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, the Fund has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Fund has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
 
 
15

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements – (Continued)
September 30, 2012
(Unaudited)
 
Liabilities measured at fair value on a recurring basis included the following (in thousands):
 
   
Fair Value Measurements Using
   
Liabilities
 
   
Level 1
   
Level 2
   
Level 3
   
At Fair Value
 
Interest rate swaps at September 30, 2012
  $ -     $ (318 )   $ -     $ (318 )
Interest rate swaps at December 31, 2011
  $ -     $ (773 )   $ -     $ (773 )
 
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. At December 31, 2011, the carrying value of debt approximated fair value as interest rates were comparable to current market rates.
 
Subsequent to the adoption of Accounting Standards Update 2011-04 (“ASU 2011-04”), the Fund is also required to disclose the methods used to estimate fair value on financial instruments not measured at fair value and the level within the fair value hierarchy that those fair value measurements are categorized. The carrying value and fair value of the Fund’s debt at September 30, 2012 is as follows:
 
         
Fair Value Measuring Using
   
Liabilities
 
   
Carrying Value
   
Level 1
   
Level 2
   
Level 3
   
At Fair
Value
 
September 30, 2012:
                             
Debt
  $ 9,828     $ -     $ 9,510     $ -     $ 9,510  
Note payable- related party
  $ 7,439     $ -     $ 7,439     $ -     $ 7,439  
 
The fair value of the debt was determined using quoted prices of comparable underlying securities obtained from brokers as of the measurement date.  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):
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Administrative expenses
  $ 59     $ 168     $ 223     $ 535  
Management fees
    -       -       -       -  
 
Management Fees: The General Partner is entitled to a subordinated annual asset management fee equal to 4% of gross rental payments for operating leases or 2% for full payout leases, or a competitive fee, whichever is less. Approximately $473,000 of management fees were waived for the nine month period ended September 30, 2012 and approximately $3.9 million of management fees have been waived on a cumulative basis. The General Partner has waived all future management fees.
 
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.
 
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.
 
 
16

 
LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES
Notes To Consolidated Financial Statements – (Continued)
September 30, 2012
(Unaudited)
 
Note Payable to related party:  See Note 6 for a further discussion.
 
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.
 
 
17

 
 
When used in this Form 10-Q, the words “believes” “anticipates,” “expects” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties more particularly described in other documents filed with Securities and Exchange Commission. These risks and uncertainties could cause actual results to differ materially. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly release the results of any revisions to forward-looking statements which we may make to reflect events or circumstances after the date of this Form 10-Q or to reflect the occurrence of unanticipated events.
 
The following discussion provides an analysis of our operating results, an overview of our liquidity and capital resources and other items related to us. The following discussion and analysis should be read in conjunction with (i) the accompanying interim financial statements and related notes and (ii) our consolidated financial statements, related notes, and management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2011.
 
As used herein, the terms “we,” “us,” or “our” refer to Lease Equity Appreciation Fund II, L.P. and its subsidiaries.
 
Business
 
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 are 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 the Partnership Agreement.
 
 
We acquired a diversified portfolio of new, used or reconditioned equipment that we leased 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 attempted to structure 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 focused 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.
 
Our principal objective is to generate regular cash distributions to our limited partners.
 
General Economic Overview

Economic indicators for the quarter ending September 30, 2012 show a continuation of the uneven pattern of economic activity that was seen in the first half of 2012. The overall economic landscape exhibits a stagnant condition with some sectors showing modest improvement and other sectors showing declines.  These mixed results are especially evident in the important housing market, a major engine of economic activity, as existing home sales declined 1.7% in September while new housing starts increased.  A lack of consumer and business confidence seems to be driving the lackluster economic performance. Consumer and business confidence also remains uncertain pending the outcomes of the United States of America (“U.S.”) presidential election, tax changes, the “fiscal cliff” (an automatic combination of tax increases and mandated government spending cuts), the U.S. debt ceiling, and the European debt problem.
 
 
18

 
Some specific key economic indicators and reports that were released in the third quarter of 2012 and that show the downward trend are summarized below.
 
 
·
The Commerce Department reported that durable goods orders fell 13.2% which was the largest drop since January 2009 when the economy was in recession.
 
 
·
Rising gas prices are negatively impacting consumer spending.
 
 
·
Slowing global growth is negatively impacting U.S. manufacturing which had shown signs of growth due to expanding exports.
 
 
·
The National Federation of Independent Business Optimism Index reported a drop in September 2012 and continued to indicate a “solid recession reading”. This is particularly noteworthy as small businesses comprise the majority of the equipment lease and loan obligors in our portfolios. Lack of confidence and optimism among this group does not bode well for economic expansion and job creation.
 
 
·
Business investment and capital spending, which are important contributors to economic growth, were reported to be down in the quarter ending September 2012.
 
With the presidential election looming, congressional gridlock firmly in place and uncertainty about tax policy we might expect the economy to remain stagnant in the fourth quarter. Additionally, with the looming “fiscal cliff” the outlook for 2013 is not positive with many economists now warning of the possibility of recession if the issues surrounding the “fiscal cliff” are not promptly addressed.  In such a situation the performance of our portfolio of leases and loans might be negatively impacted.

Finance Receivables and Asset Quality
 
Information about our portfolio of leases and loans is as follows (dollars in thousands):
 
   
September 30,
2012
   
December 31,
2011
 
Investment in leases and loans, net
  $ 19,140     $ 39,451  
Number of contracts
    6,900       8,800  
Number of individual end users (a)
    6,100       7,700  
Average original equipment cost
  $ 22.7     $ 24.2  
Average initial lease term (in months)
    69       66  
Average remaining lease term (in months)
    19       21  
States accounting for more than 10% of lease and loan portfolio:
               
California
    16 %     13 %
Types of equipment accounting for more than 10% of lease and loan portfolio:
               
Industrial Equipment
    32 %     27 %
Medical Equipment
    21 %     18 %
Water Purification
    12 %     13 %
Types of businesses accounting for more than 10% of lease and loan portfolio:
               
Services
    41 %     45 %
Manufacturing
    18 %     14 %
Retail Trade
    11 %     13 %
 

 
(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 1% of our portfolio based on original cost of the equipment.

 
19

 
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):
 
   
As of and for the
 
   
Nine Months Ended September 30,
 
               
Change
 
   
2012
   
2011
    $       %  
Investment in leases and loans before allowance for credit losses
  $ 19,750     $ 49,898     $ (30,148 )     (60 )%
Less: allowance for credit losses
    (610 )     (1,230 )     620       50 %
Investment in leases and loans, net
  $ 19,140     $ 48,668     $ (29,528 )     (61 )%
                                 
Weighted average investment in direct financing leases and loans before allowance for credit losses
  $ 29,457     $ 69,260     $ (39,803 )     (57 )%
Non-performing assets
  $ 906     $ 1,515     $ (609 )     (40 )%
Charge-offs, net of recoveries
  $ 2,388     $ 7,725     $ (5,337 )     (69 )%
As a percentage of finance receivables:
                               
Allowance for credit losses
    3.09 %     2.47 %                
Non-performing assets
    4.59 %     3.04 %                
As a percentage of weighted average finance receivables:
                               
Charge-offs, net of recoveries
    8.11 %     11.15 %                
 
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. The recent economic recession in the U.S. made it more difficult for some of our customers to make payments on their financings with us on a timely basis, which adversely affected our operations in the form of higher delinquencies. These higher delinquencies may continue as the U.S. economy recovers, as evidenced by an increase in our non-performing assets as a percentage of finance receivables from 4.59% at September 30, 2012 compared to 3.40% at September 30, 2011.  Our allowance for credit losses also reflects this, increasing as a percentage of our portfolio from 2.47% at September 30, 2011 to 3.09% at September 30, 2012.
 
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.

 
20

 
For a complete discussion of our critical accounting policies and estimates, see our annual report on Form 10-K for fiscal 2011 under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates.” There have been no material changes to these policies through September 30, 2012.

Results of Operations
 
Three Months Ended September 30, 2012 Compared to the Three Months Ended September 30, 2011 (dollars in thousands):
 
         
Increase (Decrease)
 
   
2012
   
2011
    $       %  
Revenues:
                         
Interest on equipment financings
  $ 543     $ 1,006       (463 )     (46 )%
Rental income
    31       176       (145 )     (82 )%
Gains/(losses) on sale of equipment and lease dispositions, net
    53       (18 )     71       (394 )%
Other income
    99       134       (35 )     (26 )%
      726       1,298       (572 )     (44 )%
                                 
Expenses:
                               
Interest expense
    633       764       (131 )     (17 )%
Interest expense - related party
    197       203       (6 )     (3 )%
Depreciation on operating leases
    17       133       (116 )     (87 )%
Provision for credit losses
    1,112       504       608       121 %
General and administrative expenses
    104       229       (125 )     (55 )%
Administrative expenses reimbursed to affiliate
    59       168       (109 )     (65 )%
Loss on derivative activities
    15       57       (42 )     (74 )%
      2,137       2,058     $ 79          
Net loss
  $ (1,411 )   $ (760 )   $ (651 )        
Net loss allocated to limited partners
  $ (1,397 )   $ (752 )     (645 )        
 
The overall decrease in revenues is primarily a result a decreasing lease and loan portfolio since the Fund is in its liquidation phase whereby it is prohibited from acquiring any new leases and loans. A more specific discussion follows:
 
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 $23.2 million for the three months ended September 30, 2012 as compared to $55.2 million for the three months ended September 30, 2011, a decrease of $32.0 million or 58.0%. 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.
 
 
·
Gains/(losses) on the sale of equipment and lease dispositions increased $71,000 to $53,000 for the three months ended September 30, 2012 compared to a net loss of $18,000 for the three months ended September 30, 2011.  Gains and losses on sales of equipment may vary significantly from period to period.
 
 
·
Other income decreased from $134,000 for the three months ended September 30, 2011 to $99,000 for the three months ended September 30, 2012, a decrease of $35,000 or 26%.  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.
 
Total expenses increased for the three month period ended September 30, 2012 primarily as a result of an increase in our provision for credit losses to $1.1 million compared to $504,000 for the three month period end September 30, 2011. We provide for credit losses when losses are likely to occur based on a migration analysis of past due payments and economic conditions. This increase is consistent with an increase in our non-performing assets and an overall deterioration in the aging of our portfolio.  Non-performing assets increased to 4.59% of our portfolio at September 30, 2012 compared to 3.04% at September 30, 2011. Additionally, current receivables as a percentage of our portfolio decreased to 88.1% at September 30, 2012 compared to 94.3% at September 30, 2011.  The increase in our provision for credit losses was partially offset by the following:
 
 
21

 
 
A significant decrease in interest expense primarily due to a decrease in average debt outstanding, partially offset by an increase in amortization of accumulated other comprehensive loss related to our interest rate swaps. Weighted average borrowings for three months ended September 30, 2012 were $16.8 million as compared to $51.8 million for the three months ended September 30, 2011. The increase in amortization of accumulated other comprehensive loss is the result of a revision in our estimate of amortizing accumulated other comprehensive loss to more closely align the recognition of accumulated other comprehensive loss with projected repayments of our borrowings, which increased our interest expense by $312,000.
 
 
A decrease in depreciation on operating leases due to continued maturity of our lease and loan portfolio.
 
 
A decrease in general and administrative expenses and administrative expenses reimbursed to affiliates due to the decrease in the size of our portfolio.
 
 
A decrease in loss on derivative activities.  The Fund has entered into interest rate swap contracts to mitigate interest rate risk associated with its variable rate debt facilities.  Mark to market changes on our interest rate swaps can vary significantly from period to period based on changes in underlying interest rates.
 
The net loss per limited partner unit, after the net loss allocated to our General Partner, for the three months ended September 30, 2012 and 2011 was $2.36 and $1.27, respectively, based on a weighted average number of limited partner units outstanding of 592,809 for both periods.
 
Nine Months Ended September 30, 2012 Compared to the Nine Months Ended September 30, 2011 (dollars in thousands):
 
               
Increase (Decrease)
 
   
2012
   
2011
    $       %  
Revenues:
                         
Interest on equipment financings
  $ 2,076     $ 4,076       (2,000 )     (49 )%
Rental income
    115       668       (553 )     (83 )%
Gains/(losses) on sale of equipment and lease dispositions, net
    122       (288 )     410       (142 )%
Other income
    418       601       (183 )     (30 )%
      2,731       5,048       (2,317 )     (46 )%
                                 
Expenses:
                               
Interest expense
    1,741       2,547       (806 )     (32 )%
Interest expense - related party
    592       672       (80 )     (12 )%
Depreciation on operating leases
    77       481       (404 )     (84 )%
Provision for credit losses
    2,238       3,635       (1,397 )     (38 )%
General and administrative expenses
    635       806       (171 )     (21 )%
Administrative expenses reimbursed to affiliate
    223       535       (312 )     (58 )%
Loss on derivative activities
    76       232       (156 )     (67 )%
      5,582       8,908       (3,326 )     (37 )%
Net loss
  $ (2,851 )   $ (3,860 )   $ 1,009          
Net loss allocated to limited partners
  $ (2,822 )   $ (3,821 )   $ 999          
 
The overall decrease in revenues is primarily a result of the Fund being in its liquidation phase whereby it is prohibited from acquiring any new leases and loans. A more specific discussion follows:
 
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 $29.5 million for the nine months ended September 30, 2012 as compared to $69.3 million for the nine months ended September 30, 2011, a decrease of $39.8 million or 57%.  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.
 
 
Gains/(losses) on the sale of equipment and lease dispositions increased to a gain of $122,000 at September 30, 2012, compared to a net loss of $288,000 for the nine months ended September 30, 2011, an increase of $410,000.  Gains and losses on sales of equipment may vary significantly from period to period.
 
 
Other income decreased from $601,000 for the nine months ended September 30, 2011 to $418,000 for the nine months ended September 30, 2012, a decrease of $183,000 or 30%.  The decrease in other income is primarily related to a decrease in late fee income, which is driven by the decrease in the size of our portfolio.
 
 
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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, partially offset by an increase in amortization of accumulated other comprehensive loss related to our interest rate swaps. Weighted average borrowings for the nine months ended September 30, 2012 were $26.1 million as compared to $63.8 million for the nine months ended September 30, 2011. The increase in amortization of accumulated other comprehensive loss is the result of a revision in our estimate of amortizing accumulated other comprehensive loss to more closely align the recognition of accumulated other comprehensive loss with projected repayments of our borrowings, which increased our interest expense by $312,000.
 
 
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, partially offset by a deterioration in the aging of our portfolio.  Non-performing assets declined to $906,000 at September 30, 2012 compared to $1.5 million at September 30, 2011, however increased as a percentage of our portfolio to 4.59% at September 30, 2012 compared to 3.04% at September 30, 2011.
 
 
·
A decrease in depreciation on operating leases directly related to a decrease in our investment in operating leases.
 
 
·
A decrease in general and administrative expenses and administrative expenses reimbursed to affiliates due to the decrease in the size of our portfolio.
 
 
·
A decrease in loss on derivative activities.  The Fund has entered into interest rate swap contracts to mitigate interest rate risk associated with its variable rate debt facilities.  Mark to market changes on our interest rate swaps can vary significantly from period to period based on changes in underlying interest rates.
 
The net loss per limited partner unit, after the net loss allocated to our General Partner, for the nine months ended September 30, 2012 and 2011 was $4.76 and $6.45, respectively, based on a weighted average number of limited partner units outstanding of 592,809 for both periods.
 
Liquidity and Capital Resources
 
General
 
Our major source of liquidity is from the collection of lease and loan payments.  Our primary cash requirements are for debt service, normal operating expenses, and distributions to partners.
 
We believe at this time that future net cash inflows will be sufficient to finance operations and meet debt service payments. The following table sets forth our sources and uses of cash for the periods indicated (in thousands):
 
   
Nine Months Ended
 September 30,
 
   
2012
   
2011
 
Net cash (used in) provided by operating activities
  $ (476 )   $ 588  
Net cash provided by investing activities
    18,118       33,850  
Net cash used in financing activities
    (17,279 )     (34,648 )
Increase (decrease) in cash
  $ 363     $ (210 )
 
During the nine months ended September 30, 2012, cash increased by $363,000 primarily due to net proceeds from leases and loans of $18.1 million and a decrease in restricted cash of $12.3 million, partially offset by debt repayments of $28.1 million, distributions to our partners of $903,000, and cash used in operating activities of $476,000.
 
Partners’ distributions paid for the nine months ended September 30, 2012 and 2011 were $903,000 and $899,000, respectively.  Cumulative partners distributions paid from our inception to September 30, 2012 were $20.0 million.  To date, limited partners have received approximately 34% of their original amount invested, depending upon when the investment was made.   Management is working to maximize the amount that can be distributed to limited partners in the future. Partners’ distributions were made at a rate of 2.0% per annum in 2012 and 2011.  Future cash distributions are not guaranteed and are solely dependent on our performance and are impacted by a number of factors which include lease and loan defaults by our customers accelerated principal payments on our debt facilities required per our agreements and prevailing economic conditions.
 
 
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The General Partner is entitled to a subordinated annual asset management fee equal to 4% of gross rental payments for operating leases or 2% for full payout leases, or a competitive fee, whichever is less. Approximately $473,000 of management fees were waived for the nine month period ended September 30, 2012 and approximately $3.9 million of management fees have been waived on a cumulative basis. The General Partner has waived all future management fees.
 
Borrowings

We have a term loan with Portigon Financial Services (Portigon or the Lender), previously known as WestLB AG, that had $9.8 million outstanding as of September 30, 2012.  Interest on originations that were financed prior to March 2009 is calculated at London Interbank Offered Rate (“LIBOR”) plus 1.20% per year. Interest on originations financed under this facility after March 2009 are at a rate of LIBOR plus 2.50% per year. As of September 30, 2012, $12.6 million of leases and loans and $749,000 of restricted cash were pledged as collateral under this facility. This facility is due in December, 2013 (maturity date).
 
On April 7, 2011 we were notified by Portigon that we were in default on our loan agreement due to various ongoing covenant breaches.  These breaches relate to the percentage of defaulted leases in its portfolio, the percentage of defaulted leases in the overall lease portfolio serviced by the General Partner, and a required minimum credit support amount, among others.  On June 29, 2012, we amended our agreement with the Lender whereby the Lender waived its right to pursue any of its rights or remedies on the existing covenant breaches.  Additionally, the agreement was amended to remove certain covenants from the loan agreement. Accordingly, as of September 30, 2012 we were in compliance with the term facility. The parties also agreed that the maturity date of the loan will be the earlier of (a) December 21, 2013 or (b) the date on which an event of default under the loan agreement occurs, at which time our special purpose entity subsidiary is required to repay the outstanding balance of the loan.  In exchange for the foregoing, we and RAI have agreed to a limited guaranty of a portion of the remaining amount due to the Lender.  The Lender has further agreed to accept a discount on a payoff of the loan at the maturity date in the event the natural runoff of the portfolio had not paid off the loan balance prior to such date.

We paid off the remaining balance of the 2007-1 Term Securitization on August 20, 2012.
 
In addition to the borrowings discussed above, we owe $7.4 million to Resource Capital Corporation, Inc. (“RSO”) as of September 30, 2012, which is a related entity of ours through common management with RAI.  On June 3, 2011, we paid a 1% fee to extend the note maturity date from March 4, 2011 to February 15, 2012 and to reduce the interest rate from 12% to 10% per annum.   On February 15, 2012, the Fund incurred an additional 1% fee, or $77,000, to RSO to further extend the maturity date of the note payable to related party from February 15, 2012 to February 15, 2013.   Prior to the repayment of the 2007-1 Term Securitization, monthly payments were made at approximately 0.3% of the outstanding principal and interest payable quarterly. Subsequent to the payoff of the 2007-1 Term Securitization we began to apply cash receipts on leases and loans that had been pledged as collateral on the 2007-1 Term Securitization to repayment of the related party note payable.  Interest payments on the note payable were $592,000 and $672,000 for the nine month periods ended September 30, 2012 and 2011, respectively.
 
Liquidity Summary
 
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.
 
Our primary use of cash is for debt service, of which substantially all of our leases and loans are pledged as collateral. Repayment of our debt is based on the payments we receive from our customers. If a lease or loan becomes delinquent our lender uses the excess collateral from performing leases to repay our loan, even though our customer has not paid us. Therefore, higher than expected lease and loan defaults will reduce our liquidity.
 
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.
 
 
Quantitative and Qualitative Disclosures about Market Risk have been omitted as permitted under rules applicable to smaller reporting companies.
 
 
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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.
 
Changes in Internal Control over Financial Reporting
 
There has been no change in our internal control over financial reporting that occurred during the three months ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 
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PART II. OTHER INFORMATION
 
ITEM 6 –
 
Exhibit
No.
 
Description
3.1
 
Certificate of Limited Partnership for Lease Equity Appreciation Fund II, L.P. (1)
3.2
 
Amended Certificate of Limited Partnership for Lease Equity Appreciation Fund II, L.P.(2)
3.3
 
Amended and Restated Agreement of Limited Partnership for Lease Equity Appreciation Fund II, L.P. (4)
4.1
 
Forms of letters sent to limited partners confirming their investment (1)
10.1
 
Origination & Servicing Agreement among LEAF Financial Corporation, Lease Equity Appreciation Fund II, L.P. and LEAF Funding, Inc. dated April 15, 2005 (3)
10.2
 
Secured Loan Agreement dated as of June 1, 2005 with LEAF Fund II, LLC as Borrower, LEAF Funding, Inc. as Originator, Lease Equity Appreciation Fund II, L.P. as Seller, LEAF Financial Corporation as Servicer, U.S. Bank National Association, as Collateral Agent and Securities Intermediary and WestLB AG, New York Branch as Lender (3)
10.3
 
First Amendment to WestLB AG, New York Branch, Secured Loan Agreement (5)
10.4
 
Second Amendment to WestLB AG, New York Branch, Secured Loan Agreement (6)
10.5
 
Third Amendment to WestLB AG, New York Branch, Secured Loan Agreement (7)
10.6
 
Fifth Amendment to WestLB AG, New York Branch, Secured Loan Agreement (8)
10.7
 
Sixth Amendment to WestLB AG, New York Branch, Secured Loan Agreement (9)
10.8
 
Indenture among LEAF II Receivables Funding, LLC as issuer, and U.S. Bank National Association as trustee and custodian (9)
10.9
 
Seventh Amendment to WestLB AG, New York Branch, Secured Loan Agreement (10)
10.10
 
Eighth Amendment to WestLB AG, New York Branch, Secured Loan Agreement (10)
10.11
 
Ninth Amendment to WestLB AG, New York Branch, Secured Loan Agreement (11)
10.12
 
Tenth Amendment to WestLB AG, New York Branch, Secured Loan Agreement (11)
10.13
 
Eleventh Amendment to WestLB AG, New York Branch, Secured Loan Agreement (11)
10.14
 
Twelfth Amendment to WestLB AG, New York Branch, Secured Loan Agreement (12)
10.15
 
Thirteenth Amendment to WestLB AG, New York Branch, Secured Loan Agreement (12)
10.16
 
Fourteenth Amendment to West LB AG, New York Branch, Secured Loan Agreement (12)
10.17
 
Fifteenth Amendment to West LB AG, New York Branch, Secured Loan Agreement (13)
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Certification of Chief Executive Officer pursuant to Section 1350 18 U.S.C., as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
Certification of Chief Financial Officer pursuant to Section 1350 18 U.S.C., as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101
 
Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets at September 30, 2012 and December 31, 2011; (ii) the Consolidated Statements of  Operations for the three and nine month periods ended September 30, 2012 and 2011; (iii) the Consolidated Statements of Comprehensive Loss for the three and nine month periods ended September 30, 2012 and 2011; (iv) the Consolidated Statement of Changes in Partners’ Deficit for the nine month period ended September 30, 2012; (iv) the Consolidated Statements of Cash Flows for the periods ended September 30, 2012 and 2011; and, (iv) the Notes to Consolidated Financial Statements.

 
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(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.

 
27

 
 
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.
 
  LEASE EQUITY APPRECIATION FUND II, L.P.  
  Delaware Limited Partnership  
       
 
By:
LEAF Financial Corporation,  its General Partner
 
       
November 14, 2012
By:
/s/ CRIT S. DEMENT
 
   
CRIT S. DEMENT
 
   
Chief Executive Officer
 
       
November 14, 2012
By:
/s/ ROBERT K. MOSKOVITZ
 
   
ROBERT K. MOSKOVITZ
 
   
Chief Financial Officer
 
 
 
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