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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 June 30, 2014

 

OR

¨

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)

___________________

 

 

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.    x Yes   ¨ 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):

 

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.

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LEASE EQUITY APPRECIATION FUND II, L.P.

INDEX TO QUARTERLY REPORT

ON FORM 10-Q

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PART1. FINANCIAL INFORMATION

ITEM I – FINANCIAL STATEMENTS

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.

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Consolidated Statements of Operations

(In thousands, except unit data)

(Unaudited)

 

 

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

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

(Unaudited)

 

 

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

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Consolidated Statement of Changes in Partners’ Deficit

(In thousands, except unit data)

(Unaudited)

 

 

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

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

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

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

June 30, 2014

(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 beginning of 2033. The Fund entered its liquidation period in October 2011. Contractually, the Fund will terminate on December 31, 2033, 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 June 30, 2014, in addition to its 1% general partnership interest, the General Partner also had invested $1.0 million for a 2.02% limited partnership interest in the Fund.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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 June 30, 2014, and the results of its operations and cash flows for the periods presented. The results of operations for the three and six months ended June 30, 2014 are not necessarily indicative of results of the Fund’s operations for the 2014 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, 2013, as filed with the SEC on March 31, 2014.

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 and the estimated unguaranteed residual values of leased equipment, among others.  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.

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Notes To Consolidated Financial Statements - (Continued)

June 30, 2014

(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.  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.

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Notes To Consolidated Financial Statements - (Continued)

June 30, 2014

(Unaudited)

Derivative Instruments

The Fund previously entered into derivative contracts, all of which have been terminated, 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

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 $5,000 and $24,000 for the three and six months ended June 30, 2014, respectively, and $53,000 and $122,000 for the three and six months ended June 30, 2013, respectively.

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Notes To Consolidated Financial Statements - (Continued)

June 30, 2014

(Unaudited)

NOTE 3 – INVESTMENT IN LEASES AND LOANS

The Fund’s investment in leases and loans, net, consists of the following (in thousands):

 

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(a)

The Fund’s direct financing leases are for initial lease terms generally ranging from 24 to 144 months.

(b)

The interest rates on loans generally range from 5% to 17%.

The components of direct financing leases and loans are as follows (in thousands):

 

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(a)

Unguaranteed residuals for direct 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):

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Notes To Consolidated Financial Statements - (Continued)

June 30, 2014

(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 $100,000 and $370,000) as of June 30, 2014 and December 31, 2013, respectively (in thousands):

The Fund had $30,000 and $420,000 of leases and loans on nonaccrual status as of June 30, 2014 and December 31, 2013, respectively.  The credit quality of the Fund’s investment in leases and loans is as follows (in thousands):

The following table summarizes the activity in the allowance for credit losses (in thousands):

 

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(a)

End of period balances were collectively evaluated for impairment.

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Notes To Consolidated Financial Statements - (Continued)

June 30, 2014

(Unaudited)

NOTE 5 – DEFERRED FINANCING COSTS

As of December 31, 2013, there was $8,000 of unamortized deferred financing costs which were fully amortized during the six months ended June 30, 2014.

NOTE 6 – NOTE PAYABLE TO RELATED PARTY

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, $4.7 million and $5.7 million as of June 30, 2014 and December 31, 2013, respectively, on a note payable which bears interest at 10% per annum.  In December 2013, the maturity date was extended on the related party note payable from February 2014 to February 2015.  Interest payments on the note payable were $270,000 and $320,000 for the six months ended June 30, 2014 and 2013, respectively.  As of June 30, 2014, $3.1 million of gross leases and loans were pledged as collateral for this note.

Repayments:  Estimated annual principal payments on the Fund’s aggregate borrowings over the next annual period ended June 30 are as follows (in thousands):

NOTE 7 – DERIVATIVE INSTRUMENTS

The Fund previously managed interest rate risk by employing a hedging strategy using derivative financial instruments such as interest rate swaps.  The Fund did not use derivative financial instruments for trading or speculative purposes. The Fund managed the credit risk of possible counterparty default in these derivative transactions by dealing primarily with counterparties with investment grade ratings.  The swaps were terminated in November 2013 in correlation with the pay down of the Portigon debt.

The following table summarizes the effect of the interest rate swaps on the consolidated statements of operations and other comprehensive loss for the six month periods ended June 30, 2013 (in thousands):

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(a)

Losses reclassified from accumulated other comprehensive loss were recognized in loss on derivative activities on the accompanying statement of operations.

(b)

All changes in fair value were recognized in loss on derivative activities and all cash payments on derivatives were recognized in interest expense. The Fund recognized an expense of $133,000 in interest expense for the six month periods ended June 30, 2013, related to cash payments on derivatives.  Changes in fair value of $130,000 were recognized as a reduction to expense within loss on derivative activities for the six month periods ended June 30, 2013.

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Notes To Consolidated Financial Statements - (Continued)

June 30, 2014

(Unaudited)

 

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 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.

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 June 30, 2014 and December 31, 2013 is as follows:

The fair value of the related party note payable was determined based on the expected future discounted cash flows.

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LEASE EQUITY APPRECIATION FUND II, L.P. AND SUBSIDIARIES

Notes To Consolidated Financial Statements - (Continued)

June 30, 2014

(Unaudited)

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):

Management Fees. The General Partner has waived management fees since December 2009.  Through June 30, 2014, the General Partner has waived management fees of $4.2 million, of which $45,000 related to the six months ended June 30, 2014.

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 owed to the General Partner and its affiliates for various items such as management fees, expense reimbursements, and the acquisition and management of equipment portfolios.  These amounts are expected to be repaid.

Distributions.  The General Partner owns a 1% general partner interest and a 2.02% limited partner interest in the Fund. The General Partner was paid cash distributions of $6,000 and $12,000 for its general partner interests and limited partner interests in the Fund, respectively, for the six months ended June 30, 2013.  There were no distributions made during 2014.

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.

NOTE 11 – SUBSEQUENT EVENTS

The Fund has evaluated its June 30, 2014 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.

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ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, 2013.

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 beginning of 2033. We entered our liquidation period in October 2011 and will terminate on December 31, 2033, 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.

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.  Management has worked to maximize the amount distributed to limited partners via regular cash distributions.  As we entered the liquidation phase of the partnership in October 2011, 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.  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 and that it does not anticipate making any additional distributions.

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General Economic Overview

For the quarter ended June 30, 2014, U.S. economic activity showed overall slow but steady growth in many sectors of the economy especially in the small business sector.  The severe weather experienced in the first quarter of 2014 has had a lagging effect on economic performance but there are signs of a rebound in the second quarter 2014 performance.   With no changes in monetary policy from the Federal Reserve, and no legislative initiatives expected from the Congress until after the November 2014 election, the economy is expected to continue to grow at a slow pace through the remainder of 2014 barring international shocks from the Ukraine crisis, Iraq or similar events.  Some specific key economic indicators and reports that were released in the second quarter of 2014 that have specific relevance for small to medium size business performance are summarized below.  The indicators show overall positive trends. These indicators have especially important relevance to us as loans and leases to small to medium size businesses comprise the majority of our portfolio.

·

The Monthly Confidence Index reported by The Equipment Leasing & Finance Foundation for June 2014 was 61.4; down from 65.1 at the March 2014 report (over 50 is considered positive). The Monthly Confidence Index measures lease and finance company executive sentiment with respect to availability of capital, plans on hiring, and overall U.S. economic trends.  While down slightly from the prior report the Index reflected the sentiment of the majority of the executives that business conditions will remain the same or improve over the next four months.

·

The National Association of Realtors reported in June 2014 that home prices increased in most of the country and were 5.1% higher than prior year levels.  Additionally existing home sales rose 4.9% at an annual rate as compared to the prior month.  These are important economic indicators because rising home prices generally contribute to an improvement in consumer sentiment which can drive consumer spending, the most important driver of economic growth.

·

On July 1, 2014 the Thomson Reuters/PayNet Small Business Lending Index which measures the volume of lending to small businesses showed an increase of 12 % as compared to the prior year period.  Commentary in the report stated “The index has risen at double digit rates for three consecutive months signaling growing confidence among small companies and further GDP growth.”

·

The National Federation of Independent Business reported that its Small Business Optimism Index increased to 96.6 in June 2014. This is the highest level since September 2007 approaching the onset of the Great Recession.  The Index measures ten different items including small business sentiment about business expansion, hiring, and sales trends.

·

The National Association of Credit Management Index (“CMI”) for June 2014 measured 56.1 which was higher than the 55.6 for the last quarter end but down from 56.8 in May 2014 (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 recent CMI numbers suggest a still sluggish but slowly growing economy. The CMI has remained over 50 for more than a year and CMI Index also noted an expansion in credit extended to business.

·

The June 2014 Institute of Supply Management reported its PMI Index on the manufacturing sector showed continued expansion,  and the June 2014 PMI index of 53.7 (any number over 50 indicates growth) was at its highest level since May 2010.

·

The 2014 Equipment Leasing & Finance Foundation’s U.S. Economic Outlook update released in early July 2014 reported that the U.S. investment in equipment and software is expected to grow 2.6% in 2014 which is down from an initial forecast of 2.8% as a result of the sluggish first quarter weather related performance.

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 our portfolio.

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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 12% of our portfolio based on original cost of the equipment.

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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):

Our allowance for credit losses is our estimate of losses inherent in our commercial finance receivables, at the current time. 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 overall non-performing assets and charge-offs, net of recoveries.  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 an increase in charge-offs, net of recoveries as a percentage of weighted average finance receivables.

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.

For a complete discussion of our critical accounting policies and estimates, see our annual report on Form 10-K for fiscal 2013 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 June 30, 2014.

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Results of Operations

Three Months Ended June 30, 2014 Compared to the Three Months Ended June 30, 2013 (dollars in thousands):

The overall decrease in revenues is primarily a result of a decreasing lease and loan portfolio as we are in our liquidation phase whereby we are 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 $3.8 million for the three months ended June 30, 2014 as compared to $9.3 million for the three months ended June 30, 2013, a decrease of $5.5 million or 59%.  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 on sales of equipment and lease dispositions decreased $109,000 to a gain of $11,000 for the three month period ended June 30, 2014 compared to a net gain of $120,000 for the three month period ended June 30, 2013.  Gains on sales of equipment may vary significantly from period to period.

·

Other income decreased from $65,000 for the three months ended June 30, 2013 to $8,000 for the three months ended June 30, 2014, a decrease of $57,000 or 88%.  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.

Excluding the increase in the provision for credit losses, all other expenses decreased for the three month period ended June 30, 2014 as a result of the decrease in the size of our portfolio.  We recorded a provision for credit losses of $432,000 for the three month period ended June 30, 2014 compared to a reduction to our provision of $438,000 for the three month period ended June 30, 2013, resulting from a decrease in our allowance 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, in addition to various qualitative factors.  The decrease in all other expenses was primarily due to the following:

·

A decrease in interest expense, due to a reduction of average debt outstanding, and a decrease in loss on derivative activities, due to the termination of the derivative contracts in relation to the November 2013 term loan payoff.

·

A decrease in interest expense to related party.  Subsequent to the repayment of our 2007-1 Term Securitization in August 2013, 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.

·

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.

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The net loss per limited partner unit, after the net loss allocated to our General Partner, for the three months ended June 30, 2014 was $0.94 compared to net income per limited partner unit of $0.58 for the three months ended June 30, 2013, based on a weighted average number of limited partner units outstanding of 592,809 for both periods.

Six Months Ended June 30, 2014 Compared to the Six Months Ended June 30, 2013 (dollars in thousands):

The overall decrease in revenues is primarily a result of a decreasing lease and loan portfolio as we are in our liquidation phase whereby we are 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 $4.3 million for the six months ended June 30, 2014 as compared to $11.0 million for the six months ended June 30, 2013, a decrease of $6.7 million or 61%.  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 on sales of equipment and lease dispositions decreased $22,000 to a gain of $81,000 for the six month period ended June 30, 2014 compared to a net gain of $103,000 for the six month period ended June 30, 2013.  Gains on sales of equipment may vary significantly from period to period.

·

Other income decreased from $143,000 for the six months ended June 30, 2013 to $27,000 for the six months ended June 30, 2014, a decrease of $116,000 or 81%.  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.

Excluding the increase in the provision for credit losses, all other expenses decreased for the six month period ended June 30, 2014 as a result of the decrease in the size of our portfolio.  We recorded a provision for credit losses of $505,000 for the six month period ended June 30, 2014 compared to a provision for credit losses of $281,000 for the six month period ended June 30, 2013.  We provide for credit losses when losses are likely to occur based on a migration analysis of past due payments and economic conditions, in addition to various qualitative factors.  The decrease in all other expenses was primarily due to the following:

·

A decrease in interest expense, due to a reduction of average debt outstanding, and a decrease in loss on derivative activities, due to the termination of the derivative contracts in relation to the November 2013 term loan payoff.

·

A decrease in interest expense to related party.  Subsequent to the repayment of our 2007-1 Term Securitization in August 2012, 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.

·

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.

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The net loss per limited partner unit, after the net loss allocated to our General Partner, for the six months ended June 30, 2014 and 2013 was $1.09 and $1.28, 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.  As discussed below, we notified our limited partners that we will cease making regular cash distributions in November 2013 and do not anticipate making any additional distributions.  Accordingly, we plan to fund future operating expenses from cash remaining after payments for debt service.  In addition, we are exploring ways to liquidate the fund.

The following table sets forth our sources and uses of cash for the periods indicated (in thousands):

During the six months ended June 30, 2014 cash increased by $290,000 primarily due to proceeds from leases and loans of $1.666 million that exceeded our affiliated note repayments of $1.076 million and cash used in operating activities of $300,000.

The General Partner has waived management fees since December 2009.  Through June 30, 2014, the General Partner has waived management fees of $4.2 million, of which $45,000 related to the six months ended June 30, 2014.

Borrowings

We previously had a loan to Portigon Financial Services (Portigon or the Lender) that matured and was paid off in November 2013.

We owe $4.7 million to Resource Capital Corporation, Inc. (“RSO”) as of June 30, 2014, which is a related entity of the Fund through common management with RAI, on a note payable which bears interest at 10% per annum.  In December 2013, we extended the maturity date of the related party note payable from February 2014 to February 2015.

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.

Cumulative partner distributions paid from our inception to June 30, 2014 were $21.2 million and were made at a rate of 2.0% per annum in 2013 before the regular cash distributions were discontinued in November 2013.  Future cash distributions, if any, to the limited partners will be made after all the liabilities of the Fund are paid.  At this time we do not expect any additional cash distributions to the limited partners.

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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.

ITEM 3 – 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.

ITEM 4 – 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.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during the quarter ended June 30, 2014 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 – EXHIBITS

 

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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.

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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.

 

 

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