UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

ANNUAL REPORT

 

 

(Mark One)

SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2009

 

OR

 

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _______________ to _______________

Commission file number 001-31616

 

INTERNATIONAL LEASE FINANCE CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (310) 788-1999

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES x  NO o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o  NO x

 

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. YES x  NO o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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). YES o  NO o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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 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 Exchange Act). YES o  NO x

 

As of June 30, 2009 and February 26, 2010, there were 45,267,723 shares of Common Stock, no par value, outstanding, all of which were held by affiliates.

 

Registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this form with the reduced disclosure format.

 

 

INTERNATIONAL LEASE FINANCE CORPORATION

 

2009 FORM 10-K ANNUAL REPORT

 

 

TABLE OF CONTENTS

 

 

General

 

International Lease Finance Corporation’s (the “Company,” “ILFC,” “management,” “we,” “our,” “us”) primary business operation has historically been to acquire new commercial jet aircraft from The Boeing Company (“Boeing”) and Airbus S.A.S. (“Airbus”) and lease those aircraft to airlines throughout the world. Until we have addressed our current financial position, we will likely not pursue any new aircraft purchases over and above our current contracted deliveries. We will continue to lease our existing fleet and provide fleet management services to investors and/or owners of aircraft portfolios for a management fee. In addition to our leasing and fleet management activities, at times we sell aircraft from our leased aircraft fleet to other leasing companies, financial services companies, and airlines and remarket and sell aircraft owned by others for a fee. We have also provided asset value guarantees and a limited number of loan guarantees to buyers of aircraft or to financial institutions for a fee.

 

As of December 31, 2009, we owned 993 jet aircraft, had 11 additional aircraft in the fleet classified as finance and sales-type leases and provided fleet management services for 99 aircraft. See “Item 2. Properties — Flight Equipment.” At December 31, 2009, we had contracted with Boeing and Airbus to purchase 120 new aircraft, all negotiated in U.S. dollars, for delivery through 2019 with an estimated purchase price of $13.7 billion. See “Item 2. Properties — Commitments.”

 

We maintain a variety of flight equipment to provide a strategic mix and balance so as to meet our customers’ needs and to maximize our opportunities. To minimize the time that our aircraft are not leased to customers, we have concentrated our aircraft purchases on models of new and used aircraft which we believe will have the greatest airline demand and operational longevity. To date, we have been able to purchase aircraft on terms which have permitted us to lease our aircraft portfolio at a profit.

 

We have generally financed our aircraft purchases through available cash balances, internally generated funds and debt financings. A combination of the challenges facing our parent, American International Group, Inc. (“AIG”), the downgrades in our credit ratings by the rating agencies, and the turmoil in the credit markets has severely limited our ability to access the commercial paper and unsecured debt markets.

 

 

See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Consideration of ILFC’s Ability to Continue as a Going Concern.”

 

The airline industry is cyclical, economically sensitive and highly competitive. Our continued success is largely dependent on management’s ability to develop customer relationships for leasing, sales, remarketing and

fleet management services with airlines and other customers best able to maintain their economic viability and survive in the competitive environment in which they operate.

 

The Company is incorporated in the State of California and its principal offices are located at 10250 Constellation Blvd., Suite 3400, Los Angeles, California 90067. Our telephone number, facsimile number and website address are (310) 788-1999, (310) 788-1990, and www.ilfc.com, respectively. Our EDGAR filings with the United States Securities and Exchange Commission (“SEC”) are available, free of charge, on our website or by written request to us. The information on our website is not part of or incorporated by reference into this report.

 

We are an indirect wholly-owned subsidiary of AIG. AIG is a holding company which, through its subsidiaries, is engaged in a broad range of insurance and insurance-related activities in the United States of America (“U.S.”) and abroad. AIG’s primary activities include both general insurance and life insurance and retirement services operations. Another significant activity is financial services. The common stock of AIG is listed on, among others, the New York Stock Exchange. Since September 2008, AIG has been working to protect and enhance the value of its key businesses, execute an orderly asset disposition plan, and position itself for the future. AIG has entered into several important transactions and relationships with the FRBNY, the AIG Credit Facility Trust, and the United States Department of Treasury. As a result of these arrangements, AIG is controlled by the AIG Credit Facility Trust, which was established for the sole benefit of the United States Treasury. AIG is exploring alternative restructuring opportunities for ILFC. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Result of Operations — Our Relationship with AIG.”

 

Recent Developments

 

On February 5, 2010, Steven F. Udvar-Hazy retired as a director and our Chief Executive Officer and John L. Plueger, our President and Chief Operating Officer, was named Acting Chief Executive Officer. Additionally, Julie I. Sackman, our Executive Vice President, General Counsel and Secretary, has informed us that she will retire effective May 1, 2010. Brian M. Monkarsh, formerly Vice President and Corporate Counsel, has been named Senior Vice President and Assistant General Counsel.

 

Aircraft Leasing

 

We lease most of our aircraft under operating leases. The cost of the aircraft is not fully recovered over the term of the initial lease, and we retain the benefit as well as assume the risk of the residual value of the aircraft. In accordance with accounting principles generally accepted in the U.S. (“GAAP”), rentals are reported ratably as revenue over the lease term, as they are earned. The aircraft under operating leases are included as Flight equipment under operating leases on our Consolidated Balance Sheets and are depreciated to an estimated salvage value over the estimated useful lives of the aircraft. On occasion we enter into finance and sales-type leases where the full cost of the aircraft is substantially recovered over the term of the lease. The aircraft under finance and sales-type leases are recorded on our Consolidated Balance Sheets in Net investment in finance and sales-type leases. With respect to these leases, we record lease payments received as a reduction in the net investment in the finance/sales-type leases and interest income using an interest rate implicit in the lease. At December 31, 2009, we accounted for 993 aircraft as operating leases and 11 aircraft as finance and sales-type leases.

 

The initial term of our current leases range in length from one year to 15 years with current maturities through 2021. See “Item 2. Properties — Flight Equipment” for information regarding scheduled lease terminations. We attempt to maintain a mix of short-, medium- and long-term leases to balance the benefits and risks associated with different lease terms and changing market conditions. Varying lease terms help to mitigate the effects of changes in prevailing market conditions at the time aircraft become eligible for re-lease or are sold.

 

All leases are on a “net” basis with the lessee responsible for all operating expenses, which customarily include fuel, crews, airport and navigation charges, taxes, licenses, registration and insurance. In addition, the lessee is responsible for normal maintenance and repairs, airframe and engine overhauls, and compliance with return conditions of flight equipment on lease. We may, in connection with the lease of a used aircraft, agree to contribute to the cost of certain major overhauls or modifications depending on the condition of the aircraft at delivery. Under the provisions of many leases, for certain airframe and engine overhauls, we reimburse the lessee for costs incurred up to, but not exceeding, related overhaul rentals the lessee has paid to us. Such rentals are included in the caption

Rental of flight equipment in our Consolidated Statements of Income. We provide a charge to operations based on the estimated reimbursements during the life of the lease. This amount is included in Provision for overhauls in our Consolidated Statements of Income.

 

The lessee is responsible for compliance with all applicable laws and regulations with respect to the aircraft. We require our lessees to comply with the standards of either the United States Federal Aviation Administration (the “FAA”) or its foreign equivalent. Generally, we require a deposit as security for the lessee’s performance of obligations under the lease and the condition of the aircraft upon return. In addition, the leases contain extensive provisions regarding our remedies and rights in the event of a default by the lessee and specific provisions regarding the condition of the aircraft upon return of the aircraft. The lessee is required to continue to make lease payments under all circumstances, including periods during which the aircraft is not in operation due to maintenance or grounding.

 

Some foreign countries have currency and exchange laws regulating the international transfer of currencies. When necessary we require, as a condition to any foreign transaction, that the lessee or purchaser in a foreign country obtain the necessary approvals of the appropriate government agency, finance ministry or central bank for the remittance of all funds contractually owed in U.S. dollars. We attempt to minimize our currency and exchange risks by negotiating most of our aircraft leases in U.S. dollars. All guarantees obtained to support various lease agreements are denominated for payment in the same currency as the lease.

 

To meet the needs of our customers, a few of our leases are negotiated in Euros. As the Euro to U.S. dollar exchange rate fluctuates, airlines’ interest in entering into Euro denominated lease agreements will change. After we agree to the rental payment currency with an airline, the negotiated currency remains for the term of the lease. We had hedged Euro denominated lease payment cash flows generated by leases that were in effect at March 11, 2005 through February 2010. The economic risk arising from foreign currency denominated leases has, to date, been immaterial to us.

 

Management obtains and reviews relevant business materials from all prospective lessees and purchasers before entering into a lease or extending credit. Under certain circumstances, the lessee may be required to obtain guarantees or other financial support from an acceptable financial institution or other third parties.

 

During the life of the lease, situations may lead us to restructure leases with our lessees. Historically, restructurings have involved the voluntary termination of leases prior to lease expiration, the arrangement of subleases from the primary lessee to another airline, the rescheduling of lease payments, and modifications of the length of the lease. When we repossess an aircraft, we frequently export the aircraft from the lessee’s jurisdiction. In the majority of these situations, we have obtained the lessee’s cooperation and the return and export of the aircraft was immediate. In some situations, however, the lessees have not fully cooperated in returning aircraft. In those cases we have taken legal action in the appropriate jurisdictions. This process has delayed the ultimate return and export of the aircraft. In addition, in connection with the repossession of an aircraft, we may be required to pay outstanding mechanic, airport, and navigation fees and other amounts secured by liens on the repossessed aircraft. These charges could relate to other aircraft that we do not own but were operated by the lessee. During 2009, three of our lessees filed for bankruptcy protection or ceased operations. These customers operated nine of our aircraft. As of February 25, 2010, eight of these aircraft were leased to other airlines and one of these aircraft is still available for lease. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Result of Operations — Overview — Aircraft Industry.”

 

Flight Equipment Marketing

 

We may sell our leased aircraft at or before the expiration of their leases. The buyers of our aircraft include the aircraft’s lessee and other aircraft operators, financial institutions, private investors and third party lessors. From time to time, we engage in transactions to buy aircraft for resale. In other cases, we assist our customers in acquiring or disposing of aircraft by providing consulting services and procurement of financing from third parties. Any gain or loss on disposition of leased aircraft is included in the caption Flight equipment marketing in our Consolidated Statements of Income.

From time to time, we are engaged as an agent for airlines and various financial institutions in the disposition of their surplus aircraft on a fee basis. We generally act as an agent under an exclusive remarketing contract whereby we agree to sell aircraft on a commercially reasonable basis within a fixed time period. These activities generally augment our primary activities and also serve to promote relationships with prospective sellers and buyers of aircraft. We may, from time to time, participate with banks, other financial institutions and airlines to assist in financing aircraft purchased by others and by providing asset value or loan guarantees collateralized by aircraft on a fee-basis.

 

We plan to continue to engage in providing marketing services to third parties on a selective basis involving specific situations where these activities will not conflict or compete with, but rather will complement, our leasing and selling activities.

 

Fleet Management Services

 

We provide fleet management services to third party operating lessors who are unable or unwilling to perform this service as part of their own operation. We typically provide many of the same services that we perform for our own fleet. Specifically, we provide leasing, re-leasing and sales services on behalf of the lessor for which we charge a fee. The fees for fleet management services are included in Interest and other in our Consolidated Statements of Income.

 

Financing/Source of Funds

 

We purchase new aircraft directly from manufacturers and used aircraft from airlines and other owners. In the past we have financed the purchase price of flight equipment using internally generated funds and debt financings. Since September 2008, a combination of the challenges facing our parent, AIG, the downgrades in our credit ratings by the rating agencies, and the turmoil in the credit markets has eliminated our ability to access the commercial paper market and limited our ability to issue unsecured debt. Until we have addressed our current financial position, we will likely not pursue any new aircraft purchases over and above our current contracted deliveries. We are currently seeking secured financing to meet our future liquidity needs. We may also need to seek additional funding from AIG, which funding would be subject to the consent of the FRBNY. Without additional support from AIG or if we fail to obtain secured financing from a third party lender, in the future there could exist doubt concerning our ability to continue as a going concern. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Consideration of ILFC’s Ability to Continue as a Going Concern.”

 

Customers

 

At December 31, 2009, 2008 and 2007, we leased aircraft to customers in the following regions:

 

 

 

Revenues include rentals of flight equipment to foreign airlines of $4,925,001,000 in 2009, $4,612,019,000 in 2008, and $4,175,987,000 in 2007, comprising 93.4%, 93.4%, and 91.0%, respectively, of total Rentals of flight equipment revenue. See Note J of Notes to Consolidated Financial Statements.

The following table sets forth the dollar amount and percentage of total rental revenues attributable to the indicated geographic areas based on each airline’s principal place of business for the years indicated:

 

 

The following table sets forth revenue attributable to individual countries representing at least 10% of total revenue in any year indicated below based on each airline’s principal place of business for the years indicated:

 

 

No single customer accounted for more than 10% of total revenues in any of the years disclosed.

 

Competition

 

The leasing, remarketing and sale of jet aircraft is highly competitive. We face competition from aircraft manufacturers, banks, financial institutions, other leasing companies, aircraft brokers and airlines. Competition for leasing transactions is based on a number of factors including delivery dates, lease rates, terms of lease, other lease provisions, aircraft condition and the availability in the market place of the types of aircraft to meet the needs of the customers. We believe we are a strong competitor in all of these areas.

 

Government Regulation

 

The U.S. Department of State (“DOS”) and the U.S. Department of Transportation (“DOT”), including the FAA, an agency of the DOT, exercise regulatory authority over air transportation in the U.S. The DOS and DOT, in general, have jurisdiction over the economic regulation of air transportation, including the negotiation with foreign governments of the rights of U.S. carriers to fly to other countries and the rights of foreign carriers to fly to and within the U.S.

 

We are not directly subject to the regulatory jurisdiction of the DOS and DOT or their counterpart organizations in foreign countries related to the operation of aircraft for public transportation of passengers and property.

 

Our relationship with the FAA consists of the registration with the FAA of those aircraft which we have leased to U.S. carriers and to a number of foreign carriers where, by agreement, the aircraft are to be registered in the U.S. When an aircraft is not on lease, we may obtain from the FAA, or its designated representatives, a U.S. Certificate of Airworthiness or a ferry flight permit for the particular aircraft.

 

Our involvement with the civil aviation authorities of foreign jurisdictions consists largely of requests to register and deregister our aircraft on those countries’ registries.

 

The U.S. Department of Commerce (“DOC”) exercises regulatory authority over exports. We are subject to the regulatory authority of the DOS and DOC as it relates to the export of aircraft for lease and sale to foreign entities and the export of parts to be installed on our aircraft. These Departments have, in some cases, required us to obtain export licenses for parts installed in aircraft exported to foreign countries.

 

Through its regulations, the DOC and the U.S. Department of the Treasury (through its Office of Foreign Assets Control) impose restrictions on the operation of U.S. made goods, such as aircraft and engines, in sanctioned countries. In addition, they impose restrictions on the ability of U.S. companies to conduct business with entities in those countries.

The Patriot Act of 2001 reinforced the authority of the U.S. Secretary of State and the U.S. Secretary of the Treasury to (i) designate individuals and organizations as terrorists and terrorist supporters and to freeze their U.S. assets and (ii) prohibit financial transactions with U.S. persons, including U.S. individuals, entities and charitable organizations. We comply with the provisions of this Act and we closely monitor our activities with foreign entities.

 

A bureau of the U.S. Department of Homeland Security, U.S. Customs and Border Protection, enforces regulations related to the import of our aircraft into the U.S. for maintenance or lease and the importation of parts for installation on our aircraft. We monitor our imports for compliance with U.S. Customs regulations.

 

The U.S. Bureau of Export Enforcement enforces regulations related to the export of our aircraft to other jurisdictions and the exportation of parts for installation of our aircraft. We monitor our exports for compliance with the U.S. Bureau of Export Enforcement.

 

As an indirect wholly-owned subsidiary of AIG, we are subject to examination and review by the U.S. Department of the Treasury’s Office of Thrift Supervision (“OTS”). In 1999, AIG became a unitary thrift holding company within the meaning of the Home Owners’ Loan Act when the OTS granted AIG approval to organize AIG Federal Savings Bank. AIG is subject to OTS regulation, examination, supervision and reporting requirements. In addition, the OTS has enforcement authority over AIG and its subsidiaries. Among other things, this permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of AIG’s subsidiary savings association, AIG Federal Savings Bank.

 

Employees

 

We operate in a capital intensive rather than a labor intensive business. As of December 31, 2009, we had 180 full-time employees, which we considered adequate for our business operations. Management and administrative personnel will expand or contract, as necessary, to meet our future needs. None of our employees is covered by a collective bargaining agreement and we believe that we maintain excellent employee relations. We provide certain employee benefits including retirement, health, life, disability and accident insurance plans, some of which are established and maintained by our parent, AIG.

 

AIG has received Troubled Asset Relief Program (“TARP”) funds and the Office of the Special Master for TARP Executive Compensation (“Special Master”) has imposed limitations on compensation of AIG’s highest paid employees, including our Acting Chief Executive Officer and our Chief Financial Officer (the “Principal Officers”). If the limitations on compensation created by the Special Master are not agreeable to the Principal Officers, we may not be able to retain them, which may negatively impact our ability to conduct business. See “Item 1A. Risk Factors.”

 

Insurance

 

Our lessees are required to carry those types of insurance that are customary in the air transportation industry, including comprehensive liability insurance and aircraft hull insurance. In general, we are an additional insured on liability policies carried by the lessees. We obtain certificates of insurance from the lessees’ insurance brokers. All certificates of insurance contain a breach of warranty endorsement so that our interests are not prejudiced by any act or omission of the operator-lessee. Lease agreements generally require hull and liability limits to be in U.S. dollars, which are shown on the certificate of insurance.

 

Insurance premiums are paid by the lessee, with coverage acknowledged by the broker or carrier. The territorial coverage is, in each case, suitable for the lessee’s area of operations. The certificates of insurance contain, among other provisions, a provision prohibiting cancellation or material change without at least 30 days advance written notice to the insurance broker (who is obligated to give us prompt notice), except in the case of hull war insurance policies, which customarily only provide seven days advance written notice for cancellation and may be subject to shorter notice under certain market conditions. Furthermore, the insurance is primary and not contributory, and all insurance carriers are required to waive rights of subrogation against us.

 

The stipulated loss value schedule under aircraft hull insurance policies is on an agreed value basis acceptable to us and usually exceeds the book value of the aircraft. In cases where we believe that the agreed value stated in the lease is not sufficient, we purchase additional Total Loss Only coverage for the deficiency.

Aircraft hull policies contain standard clauses covering aircraft engines. The lessee is required to pay all deductibles. Furthermore, the hull war policies contain full war risk endorsements, including, but not limited to, confiscation (where available), seizure, hijacking and similar forms of retention or terrorist acts.

 

The comprehensive liability insurance listed on certificates of insurance includes provisions for bodily injury, property damage, passenger liability, cargo liability and such other provisions reasonably necessary in commercial passenger and cargo airline operations. Such certificates of insurance list combined comprehensive single liability limits of not less than $500 million. As a result of the terrorist attacks on September 11, 2001, the insurance market unilaterally imposed a sublimit on each operator’s policy for third party war risk liability in the amount of $50 million. We require each lessee to purchase higher limits of third party war risk liability or obtain an indemnity from their government.

 

In late 2005, the international aviation insurance market unilaterally introduced exclusions for physical damage to aircraft hulls caused by dirty bombs, bio-hazardous materials and electromagnetic pulsing. Exclusions for the same type of perils could be introduced into liability policies.

 

Separately, we purchase contingent liability insurance and contingent hull insurance on all aircraft in our fleet and maintain other insurance covering the specific needs of our business operations. Insurance policies are generally placed or reinsured through AIG subsidiaries. AIG charges us directly for these insurance costs. We believe our insurance is adequate both as to coverage and amount.

 

Code of Ethics and Conduct

 

Our employees are subject to AIG’s Code of Conduct designed to assure that all employees perform their duties with honesty and integrity. In addition, our directors and officers are subject to AIG’s Director, Executive Officer, and Senior Financial Officer Code of Business Conduct and Ethics. Both of these Codes appear in the Corporate Governance section of www.aigcorporate.com.

 

Forward-Looking Statements

 

This annual report on Form 10-K contains or incorporates statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Those statements appear in a number of places in this Form 10-K and include statements regarding, among other matters, the state of the airline industry, our access to the capital markets, our ability to restructure leases and repossess aircraft, the structure of our leases, regulatory matters pertaining to compliance with governmental regulations and other factors affecting our financial condition or results of operations. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and “should” and variations of these words and similar expressions, are used in many cases to identify these forward-looking statements. Any such forward-looking statements are not guarantees of future performance and involve risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to vary materially from our future results, performance or achievements, or those of the industry, expressed or implied in such forward-looking statements. Such factors include, among others, general economic, business and industry conditions, which will, among other things, affect demand for aircraft, availability and creditworthiness of current and prospective lessees, lease rates, availability and cost of financing and operating expenses, governmental actions and initiatives and environmental and safety requirements, as well as the factors discussed under “Item 1A. Risk Factors” in this Form 10-K. We do not intend, and undertake no obligation to, update any forward-looking information to reflect actual results or future events or circumstances.

 

Our business is subject to numerous significant risks and uncertainties as described below. Many of these risks are interrelated and occur under similar business and economic conditions, and the occurrence of certain of them may in turn cause the emergence, or exacerbate the effect, of others. Such a combination could materially increase the severity of the impact on us. As a result, should certain of these risks emerge, we may need additional support from AIG or additional secured financing. Without additional support from AIG or if we fail to obtain secured financing from a third party lender, in the future there could exist doubt concerning our ability to continue as a going concern. The numerous risks and

uncertainties to which our business is subject are described below and in the section titled “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”

 

Liquidity Risk

 

We have historically depended on our access to the public debt markets and bank loans in addition to our operating cash flows, to finance the purchase of aircraft and repay our maturing debt obligations. Due to a combination of the challenges facing AIG, the downgrades in our credit ratings by the rating agencies, and the turmoil in the credit markets, we have been unable to access the commercial paper market since the third quarter of 2008, we currently have limited access to the unsecured debt markets, and the maximum amount available under our senior revolving credit facilities is outstanding.

 

We cannot determine if the commercial paper market will be available to us again, or when we will be able to access the unsecured debt markets. We are therefore currently seeking other ways to fund our purchase commitments of aircraft and future maturing debt obligations, including through secured financings and additional support from AIG. During 2009, we entered into two credit agreements aggregating $3.9 billion with AIG Funding to assist in funding our liquidity needs, including the repayment of our obligations under our $2.0 billion revolving credit agreement that matured on October 15, 2009. The credit agreements are secured by a portfolio of aircraft and other assets related to the pledged aircraft. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Debt Financings” for additional information on these credit agreements. We also increased the total amount available under our 2004 Export Credit Agency (“ECA”) facility by $1.0 billion in May 2009 and at February 25, 2010, we had approximately $682 million available under that facility to use for purchases of new Airbus aircraft through June 2010, provided we receive consent from the security trustee, as required with our current long-term debt ratings. In addition, we entered into secured financings with respect to two aircraft during the second quarter of 2009.

 

Under our existing public debt indentures and bank loans, we and our subsidiaries are permitted to incur secured indebtedness totaling up to 12.5% of consolidated net tangible assets, as defined in such debt agreements, which is currently approximately $4.7 billion. Therefore, we can currently incur additional secured financings totaling approximately $800 million under these existing debt agreements, provided we receive any required consents from the FRBNY. Furthermore, it may be possible, subject to receipt of required consents from AIG Funding, the FRBNY, and the lenders under our bank loans, for us to obtain secured financing without regard to the 12.5% consolidated net tangible asset limit referred to above (but subject to certain other limitations) by doing so through subsidiaries that qualify as non-restricted subsidiaries under our public debt indentures. We will need to seek relief from our bank lenders with regard to the 12.5% limitation. We cannot predict whether the banks, AIG Funding, or the FRBNY will consent to us incurring additional secured debt.

 

Because of the poor condition of current credit markets and AIG’s announced plans to continue to explore alternative restructuring opportunities for us, we may not be able to obtain secured financing from third parties on favorable terms, if at all. We may need to seek additional funding from AIG, which funding would be subject to the consent of the FRBNY. We cannot predict whether AIG can obtain the FRBNY’s consent to allow AIG to provide additional support to us.

 

We are also pursuing potential aircraft sales, which could aggregate up to $3.5 billion in proceeds. Proposed portfolios have been presented to potential buyers; some bids have been received and are being evaluated. In evaluating the bids we are balancing the need for funds with the long term value of holding aircraft and long term prospects for us. Significant uncertainties exist as to the aircraft comprising any actual sale portfolio, the sale price for any such portfolio, and whether we can reach an agreement with terms acceptable to the buyers and us. Furthermore, if an agreement is reached, the transaction would have to be approved by the FRBNY. Therefore, we cannot predict whether a sale of aircraft will occur.

 

Because the current market for aircraft is depressed due to the economic downturn and limited availability of buyer financing, a sale would likely result in a realized loss. Based on the range of potential aircraft portfolio sales currently being explored, the potential for impairment or realized loss could be material to the results of operations for an individual period. The amount of potential loss would be dependent upon the specific aircraft sold, the sale price, the sale date and any other sale contingencies.

If we are unable to raise sufficient cash from these strategies, we may be unable to meet our debt obligations as they become due. Further, we may not be able to meet our aircraft purchase commitments as they become due, which could expose us to breach of contract claims by our lessees and manufacturers.

 

Borrowing Risks

 

Credit Ratings Downgrade Risk — Our ability to access debt markets and other financing sources is, in part, dependent on our credit ratings. In addition to affecting the availability of unsecured financing, credit ratings also directly impact our cost of financing. Since September 2008, we have experienced multiple downgrades in our credit ratings by the three major nationally recognized statistical rating organizations. These credit rating downgrades, combined with externally generated volatility, have limited our ability to access unsecured debt markets and resulted in unattractive funding costs in the private debt markets.

 

Additionally, our current long-term debt ratings impose the following restrictions under the 1999 and 2004 ECA facilities: (i) we must receive written consent from the security trustee before we can fund Airbus aircraft deliveries under the 2004 ECA facility; (ii) we must segregate all security deposits, maintenance reserves, and rental payments received under the leases of the aircraft financed under the 1999 and 2004 ECA facilities into separate accounts controlled by the security trustees (segregated rental payments will be used to pay principal and interest on the outstanding debt); and (iii) we must file individual mortgages on the aircraft funded under the 1999 and 2004 ECA facilities in the local jurisdictions in which the respective lessees operate. At December 31, 2009, we had segregated security deposits, maintenance reserves and rental payments aggregating approximately $315 million related to aircraft funded under the 1999 and 2004 ECA facilities.

 

We do not anticipate improvement in our credit ratings until there is clarity related to our ownership structure. Further ratings downgrades could increase our borrowing costs and further limit our access to the unsecured debt markets.

 

Interest Rate Risk — We are impacted by fluctuations in interest rates. Our lease rates are generally fixed over the life of the lease. Changes, both increases and decreases, in our cost of borrowing, as reflected in our composite interest rate, directly impact our net income. We manage the interest rate volatility and uncertainty by maintaining a balance between fixed and floating rate debt, through derivative instruments and through matching debt maturities with lease maturities.

 

The interest rates that we obtain on our debt financing are a result of several components, including credit spreads, swap spreads, duration, and new issue premiums. These are all in addition to the underlying Treasury or LIBOR rates, as applicable. Volatility in our perceived risk of default, our parent’s risk of default, or in a market sector’s risk of default all have an impact on our cost of funds.

 

As mentioned above, we are currently limited to secured financings, which will increase our future cost of funds and negatively affect future earnings. A one percent increase in our composite interest rate at December 31, 2009 would have increased our interest expense by approximately $300 million annually, which would put downward pressure on our operating margins.

 

Relationship with AIG

 

AIG as Our Parent Company — We are an indirect wholly-owned subsidiary of AIG. Although neither AIG nor any of its subsidiaries is a co-obligor or guarantor of our debt securities, circumstances affecting AIG have an impact on us. We can give no assurance how further changes in circumstances related to AIG would impact us.

 

Restrictive Covenants on Our Operations — AIG experienced liquidity issues beginning in the third quarter of 2008 and has, among its several important transactions and relationships with the FRBNY, entered into the FRBNY Credit Agreement, which includes financial and other restrictive covenants. As a subsidiary of AIG, we are subject to the covenants under the FRBNY Credit Agreement. Additionally, during the fourth quarter of 2009, we entered

into two credit agreements with AIG Funding that also contain restrictive covenants. The covenants in these credit agreements restrict, among other things, our ability to:

 

 

These covenants may affect our ability to operate and finance our business as we deem appropriate.

 

AIG as Our Counterparty of Derivatives — AIG Financial Products Corp. (“AIGFP”), a wholly-owned subsidiary of AIG with an explicit guarantee from AIG, is the counterparty of all our interest rate swaps and foreign currency swaps. If our counterparty is unable to meet its obligations under the derivative contracts, it would have a material impact on our financial results and cash flows.

 

AIG Going Concern Consideration — In connection with the preparation of its annual report on Form 10-K for the year ended December 31, 2009, AIG management assessed whether AIG has the ability to continue as a going concern. After considering several factors as outlined in AIG’s Form 10-K filed on February 26, 2010, AIG’s management believes that it will have adequate liquidity to finance and operate its businesses, execute its asset disposition plan, and repay its obligations for at least the next twelve months. In connection with making their going concern assessment and conclusion, AIG management and the Board of AIG have confirmed that “as first stated by the U.S. Treasury and the Federal Reserve in connection with the announcement of the AIG Restructuring Plan on March 2, 2009, the U.S Government remains committed to continuing to work with AIG to maintain its ability to meet its obligations as they come due.” It is possible that the actual outcome of one or more of AIG’s plans could be materially different or that one or more of its significant judgments or estimates could prove to be materially incorrect. If one or more of these possible outcomes are realized, AIG may need additional U.S. government support to meet its obligations as they come due. If AIG is not able to meet its obligations as they come due, it will have a significant impact on our operations, including limiting our ability to issue new debt and to receive additional support from AIG.

 

Key Personnel Risk

 

Our senior management’s reputation and relationships with lessees and sellers of aircraft are a critical element of our business. The reduction in AIG’s common stock price has dramatically reduced the value of equity awards previously made to our key employees. Furthermore, the American Recovery and Reinvestment Act of 2009 contains restrictions on bonus and other incentive compensation payable to the five executives named in a company’s proxy statement and the next 20 highest paid employees of companies receiving TARP funds. Pursuant to the Recovery Act, the Special Master issued a Determination Memorandum with respect to AIG’s named executive officers (except for the Chief Executive Officer) and 20 highest paid employees, and reviewed AIG’s compensation arrangements for its next 75 most highly compensated employees and issued a Determination Memorandum on their compensation structures, which placed significant new restrictions on their compensation as well. Our Acting Chief Executive Officer and Chief Financial Officer are among the 25 highest paid employees who are subject to these restrictions. Historically, we have embraced a pay-for-performance philosophy. Based on the limitations placed on incentive compensation by the Determination Memoranda issued by the Special Master, it is unclear whether, for the foreseeable future, we will be able to create a compensation structure that permits us to retain and motivate our most senior and most highly compensated employees and other high performing employees who become subject to the purview of the Special Master. We also stand the risk of our key employees exploring other career opportunities due to the upheaval at AIG and related uncertainties of the future of ILFC. On February 5, 2010, Steven F. Udvar-Hazy retired as a director and our Chief Executive Officer, and Julie I. Sackman, our Executive Vice President, General Counsel and Secretary, has informed us that she will retire effective May 1, 2010. John L. Plueger, our President and Chief Operating Officer, was named Acting Chief Executive Officer, and Brian M. Monkarsh, formerly Vice President and Corporate Counsel, was named Senior Vice President and Assistant

General Counsel. The inability by us to retain and motivate our key employees could negatively impact our ability to conduct business.

 

Overall Airline Industry Risk

 

We operate as a supplier and financier to airlines. The risks affecting our airline customers are generally out of our control and impact our customers to varying degrees. As a result, we are indirectly impacted by all the risks facing airlines today. Our ability to succeed is dependent upon the financial strength of our customers. Their ability to compete effectively in the market place and manage these risks has a direct impact on us. These risks include:

 

 

To the extent that our customers are affected by these risk factors, we may experience:

 

 

Lessee Non-Performance Risk

 

Our business depends on the ability of our airline customers to meet their obligations to us and if their ability materially decreases, it may negatively affect our business, financial condition, results of operations and cash flows, as discussed above in Overall Airline Industry Risk.

 

We manage lessee non-performance risk by obtaining security deposits and overhaul rentals as well as continuous monitoring of lessee performance and future outlook.

 

Airframe, Engine and Other Manufacturer Risks

 

The supply of jet transport aircraft, which we purchase and lease, is dominated by two airframe manufacturers, Boeing and Airbus, and a limited number of engine manufacturers. As a result, we are dependent on the manufacturers’ success in remaining financially stable, producing aircraft and related components which meet

the airlines’ demands, both in type and quantity, and fulfilling their contractual obligations to us. Further, competition between the manufacturers for market share is intense and may lead to instances of deep discounting for certain aircraft types and may negatively impact our competitive pricing. Should the manufacturers fail to respond appropriately to changes in the market environment or fail to fulfill their contractual obligations, we may experience:

 

 

Aircraft Related Risks

 

Residual Value — We bear the risk of re-leasing or selling the aircraft in our fleet that are subject to operating leases at the end of their lease terms. Operating leases bear a greater risk of realizations of residual values, because only a portion of the equipment’s value is covered by contractual cash flows at lease inception. In addition to factors linked to the aviation industry in general, other factors that may affect the value and lease rates of our aircraft include (i)  maintenance and operating history of the airframe and engines; (ii) the number of operators using the particular type of aircraft; and (iii) aircraft age. If both demand for aircraft and market lease rates decrease and the conditions continue for an extended period, they could affect the market value of aircraft in our fleet and may result in impairment charges. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates — Flight Equipment.” Further, deterioration of aircraft values may create losses related to our aircraft asset value guarantees.

 

Obsolescence Risk — Aircraft are long-lived assets requiring long lead times to develop and manufacture. As a result, aircraft of a particular model and type tend to become obsolete and less in demand over time, when newer more advanced and efficient aircraft are manufactured. This life cycle, however, can be shortened by world events, government regulation or customer preferences. As aircraft in our fleet approach obsolescence, demand for that particular model and type will decrease. This may result in declining lease rates, impairment charges, or losses related to aircraft asset value guarantees.

 

Greenhouse Gas Emissions Risk — Aircraft emissions of greenhouse gases vary with aircraft type and age. In response to climate change, if any, worldwide government bodies may impose future restrictions or financial penalties on operations of aircraft with high emissions. It is unclear what effect, if any, such regulations will have on our operations.

 

Other Risks

 

Foreign Currency Risk — We are exposed to foreign currency risk through the issuance of debt denominated in foreign currencies and through leases negotiated in Euros. We reduce the foreign currency risk by negotiating the majority of our leases in U.S. dollars and by hedging all the foreign currency denominated debt through derivative instruments. If the Euro exchange rate to the U.S. dollar deteriorates, we will record less lease revenue on lease payments received in Euros.

 

Accounting Pronouncements — A joint committee of the US Financial Accounting Standards Board, or FASB, and the International Accounting Standards Board is developing a new standard for lease accounting. In March 2009, both Boards released separate Discussion Papers for which the comment period closed in July 2009. The Boards have continued to discuss and modify their views on the issues presented in the Discussion Papers. The current view is to have lessees record a “right to use” asset and a lease obligation on their statement of financial

position based upon the discounted lease payments, as defined. Lessors would record lease receivables and a performance obligation liability on their statement of financial position also based on the discounted lease payments, as defined. Lessor revenue would be modified to contain an interest income component as well as lease revenue. These views continued to be discussed and modified and are subject to further change as the Boards continue to deliberate. The Boards intend to issue an Exposure Draft of the proposed standard in the second quarter of 2010 and have a final standard promulgated by the first half of 2011. At present management is unable to assess the effects of adopting the new standard.

 

None

 

Flight Equipment

 

Historically management has frequently reviewed opportunities to acquire suitable commercial jet aircraft based not only on market demand and customer airline requirements, but also on our fleet portfolio mix, leasing strategies, and likely timeline for development of future aircraft. Before committing to purchase specific aircraft, management takes into consideration factors such as estimates of future values, potential for remarketing, trends in supply and demand for the particular type, make and model of aircraft and engines, trends in local, regional, and worldwide air travel, fuel economy, environmental considerations (e.g., nitrogen oxide emissions, noise standards), operating costs, and anticipated obsolescence. Until we have addressed our current financial position, we will likely not pursue any new aircraft purchases over and above our current contracted deliveries.

 

At December 31, 2009, all of our fleet was Stage III compliant. This means that the aircraft hold or are capable of holding a noise certificate issued under Chapter 3 of Volume 1, Part II of Annex 16 of the Chicago Convention or have been shown to comply with the Stage III noise levels set out in Section 36.5 of Appendix C of Part 36 of the Federal Aviation Regulations of the U.S. At December 31, 2009, the average age of aircraft in our fleet was 7.4 years.

 

The following table shows the scheduled lease terminations (for the minimum noncancelable period which does not include contracted unexercised lease extension options) by aircraft type for our operating lease portfolio at December 31, 2009:

 

 

The schedule excludes eight aircraft which were not subject to lease at December 31, 2009, seven of which were subsequently leased. As of February 25, 2010, leases covering 11 of the 29 aircraft with lease expiration dates in 2010 had been extended or leased to other customers.

Commitments

 

At December 31, 2009, we had committed to purchase the following new aircraft at an estimated aggregate purchase price (including adjustment for anticipated inflation) of approximately $13.7 billion for delivery as shown below. The recorded basis of aircraft may be adjusted upon delivery to reflect credits given by the manufacturers in connection with the leasing of aircraft.

 

 

 

We anticipate that a portion of the aggregate purchase price will be funded by incurring additional debt. The exact amount of the indebtedness to be incurred will depend, in part, upon the actual purchase price of the aircraft, which can vary due to a number of factors, including inflation.

 

The new aircraft listed above are being purchased pursuant to purchase agreements with each of Boeing and Airbus. These agreements establish the pricing formulas (which include certain price adjustments based upon inflation and other factors) and various other terms with respect to the purchase of aircraft. Under certain circumstances, we have the right to alter the mix of aircraft type ultimately acquired. As of December 31, 2009, we had made non-refundable deposits (exclusive of capitalized interest) with respect to the aircraft which we have committed to purchase of approximately $79 million with Boeing and $55 million with Airbus.

 

As of February 25, 2010, we had entered into contracts for the lease of new aircraft scheduled to be delivered through 2019 as follows:

 

 

 

 

We will need to find customers for aircraft presently on order, and for any new aircraft ordered, and not subject to a lease or sale contract, and we will need to arrange financing for portions of the purchase price of such equipment. Although we have been successful to date in placing new aircraft on lease and have been able to obtain adequate financing in the past, there can be no assurance as to the future continued availability of lessees or of sufficient amounts of financing on acceptable terms.

 

Facilities

 

Our principal offices are located at 10250 Constellation Blvd., Suite 3400, Los Angeles, California 90067. We occupy space under a lease which expires in 2015. As of December 31, 2009, we occupied approximately

127,000 square feet of office space. Starting in March 2009, we leased an additional 22,000 square feet, which is subleased to third parties.

 

 

Flash Airlines:  We are named in lawsuits in connection with the January 3, 2004 crash of our Boeing 737-300 aircraft on lease to Flash Airlines, an Egyptian carrier. These lawsuits were filed by the families of victims on the flight and seek unspecified damages for wrongful death, costs and fees. The initial lawsuit was filed in May 2004 in California, and subsequent lawsuits were filed in California and Arkansas. All cases filed in the U.S. were dismissed on the grounds of forum non conveniens and transferred to the French Tribunal de Grande Instance (“TGI”) civil court in either Bobigny or Paris. The Bobigny plaintiffs challenged French jurisdiction, whereupon the TGI decided to retain jurisdiction, on appeal the Paris Court of Appeal reversed, and on appeal the French Cour de Cassation elected to defer its decision pending a trial on the merits. We believe we are adequately covered in these cases by the liability insurance policies carried by Flash Airlines and we have substantial defenses to these actions. We do not believe that the outcome of these lawsuits will have a material effect on our consolidated financial condition, results of operations or cash flows.

 

Krasnoyarsk Airlines (“KrasAir”):  We leased a 757-200ER aircraft to a Russian airline, KrasAir, which is now the subject of a Russian bankruptcy-like proceeding. The aircraft lease was assigned to another Russian carrier, Air Company “Atlant-Soyuz” Incorporated, which defaulted under the lease. In the first quarter of 2009, we were informed that the Russian customs authority had seized the aircraft during a time frame we believe to be late 2008. The aircraft was seized on the basis of certain alleged violations by KrasAir with respect to the import of the aircraft, including the import type and customs fees owed. The Russian customs authority filed a case in April 2009 in the general jurisdiction court in Moscow, Russia seeking an order permitting it to confiscate the aircraft due to these alleged violations. Shortly after the lawsuit was filed, we intervened in the lawsuit in order to protect our ownership rights and informed the insurance underwriters under KrasAir’s, Atlant-Soyuz’s, and our insurance policies of this matter. In the second quarter of 2009, the court decided that the seizure of the aircraft by the Russian customs authority was improper and denied the Russian customs authority’s request to confiscate the aircraft. Also in the second quarter of 2009, another Russian airline signed a lease for the aircraft. The aircraft was returned to us by the Russian customs authority and is currently undergoing maintenance in Moscow, Russia and we are currently negotiating a resolution of all customs-related issues with the Russian customs authority. We cannot predict what the outcome of this matter will be, but we do not believe that it will be material to our consolidated financial position, results of operations or cash flows.

 

Estate of Volare Airlines (“Volare”):  In November 2004, Volare, an Italian airline, filed for bankruptcy in Italy. Prior to Volare’s bankruptcy, we leased to Volare through wholly-owned subsidiaries two A320-200 aircraft and four A330-200 aircraft. In addition, we managed the lease to Volare of one A330-200 aircraft by an entity that is a related party to us. In October 2009, the Volare bankruptcy receiver filed a claim in an Italian court in the amount of €29,592,210 against us and our related party for the return to the Volare estate of all payments made by Volare to us and our related party in the year prior to Volare’s bankruptcy filing. We have engaged Italian counsel to represent us and intend to defend this matter vigorously. We cannot predict the outcome of this matter, but we do not believe that it will be material to our consolidated financial position, results of operations or cash flows.

 

We are also a party to various claims and litigation matters arising in the ordinary course of our business. We do not believe the outcome of any of these matters will be material to our consolidated financial position, results of operations or cash flows.

 

 

We are an indirect wholly-owned subsidiary of AIG and our common stock is not listed on any national exchange or traded in any established market. We did not pay any dividends on our common stock in 2009. In 2008 and 2007 we paid and accrued dividends to our parent company aggregating $46.4 million and $38.0 million, respectively. Under the most restrictive provisions of our public debt indentures and bank credit agreements, consolidated retained earnings at December 31, 2009 in the amount of approximately $2.5 billion were unrestricted as to the payment of dividends. We are, however, currently restricted from paying dividends to AIG under the FRBNY Credit Agreement.

 

The following table summarizes selected consolidated financial data and certain operating information of the Company. The selected consolidated financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and accompanying notes included elsewhere herein.

 

 

 

 (a) See Exhibit 12.

 

 

 (c) See “Item 2. Properties — Flight Equipment.”

 

Overview

 

Our primary business operation has historically been to acquire new commercial jet aircraft from Boeing and Airbus and lease those aircraft to airlines throughout the world. Until we have addressed our current financial position, we will likely not pursue any new aircraft purchases over and above our current contracted deliveries. We will continue to lease our existing fleet and provide fleet management services to investors and/or owners of aircraft portfolios for a management fee. In addition to our leasing and fleet management activities, at times we sell aircraft from our leased aircraft fleet to other leasing companies, financial services companies and airlines, and remarket and sell aircraft owned by others for a fee. We have also provided asset value guarantees and a limited number of loan guarantees to buyers of aircraft or to financial institutions for a fee.

 

Our Fleet

 

During 2009, we took delivery of 49 new aircraft from Boeing and Airbus and sold nine aircraft from our leased fleet. As of December 31, 2009, we owned 993 aircraft, had 11 additional aircraft in the fleet classified as finance and sale-type leases, and provided fleet management services for 99 aircraft. We have contracted with Airbus and Boeing to buy 120 new aircraft for delivery through 2019 with an estimated purchase price of $13.7 billion. We anticipate the purchases to be financed in part by operating cash flows and in part by incurring additional debt.

 

Of the 120 aircraft on order, 74 are 787s from Boeing with the first aircraft currently scheduled to deliver in July 2012. The contracted delivery dates were originally scheduled from January 2010 through 2017, but Boeing has experienced delays in the production of the 787s. We have signed contracts for 29 of the 74 787s on order. The leases we have signed with our customers and our purchase agreements with Boeing are both subject to cancellation clauses related to delays in delivery dates, though as of February 25, 2010, there have been no cancellations by any party. One customer, however, with signed leases for two 787s ceased operations during the fourth quarter of 2009. We are in discussions with Boeing related to potential delay compensation and penalties for which we may be eligible. Under the terms of our 787 leases, particular lessees may be entitled to share in any compensation that we receive from Boeing for late delivery of the aircraft.

 

Debt Financing

 

We have generally financed our aircraft purchases through available cash balances, internally generated funds and debt financings. A combination of the challenges facing our parent, AIG, the downgrades in our credit ratings by the rating agencies, and the turmoil in the credit markets has eliminated our ability to access the commercial paper market and limited our access to the debt markets. We are currently seeking secured financings. See “Liquidity” below. During 2009, we entered into two credit agreements aggregating $3.9 billion with AIG Funding to assist in funding our liquidity needs, including the repayment of $2.0 billion under our revolving credit agreement that matured on October 15, 2009. The loans are secured by a portfolio of aircraft and other assets related to the pledged aircraft. In order to receive the FRBNY’s consent to the loans, we also guaranteed the repayment of AIG’s obligations under the FRBNY Credit Agreement up to an amount equal to the aggregate outstanding balance of the loans entered into with AIG Funding. See “Liquidity” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Debt Financings.”

 

Aircraft Industry and Sources of Revenues

 

Our revenues are principally derived from scheduled and charter airlines and companies associated with the airline industry. We derive more than 90% of our revenues from airlines outside of the United States. The airline industry is cyclical, economically sensitive and highly competitive. Airlines and related companies are affected by fuel prices and shortages, political or economic instability, terrorist activities, changes in national policy, competitive pressures, labor actions, pilot shortages, insurance costs, recessions, health concerns, and other political or economic events adversely affecting world or regional trading markets. Our customers’ ability to react to and cope with the volatile competitive environment in which they operate, as well as our own competitive environment, will affect our revenues and income.

We are currently seeing financial stress to varying degrees across the airline industry largely precipitated by recent volatility in fuel costs, lower demand for air travel, tightening of the credit markets, and generally worsened economic conditions. We have seen airlines declare bankruptcy, cease operations, cancel routes, eliminate jobs, and retire aircraft in an attempt to reduce capacity. The financial stress has caused a slow-down in the airline industry. We believe that these conditions will continue through most of 2010 and will have a negative impact on our future operating results through increased costs associated with repossessing and deploying aircraft. There is generally a lag before an improvement in the economic conditions result in an increase in travel and a recovery of the financial health of the airline industry. Recently we have seen freight traffic, which often is considered the bellwether of the airline industry, starting to recover, and we currently see our customers increasingly willing to extend their existing leases. This could indicate that we may see some financial recovery of the airline industry starting in late 2010.

 

We typically contract to re-lease aircraft before the end of the existing lease term and for aircraft returned before the end of the lease term, we have generally been able to re-lease aircraft within two to six months of their return. In monitoring the aircraft in our fleet for impairment charges we consider facts and circumstances, including potential sales, that would require us to modify our assumptions used in our recoverability assessments and prepare revised recoverability assessments as necessary. Further, we identify those aircraft that are most susceptible to failing the recoverability assessment and monitor those aircraft more closely, which may result in more frequent recoverability assessments. The recoverability of these aircraft is more sensitive to changes in contractual cash flows, future cash flow estimates, and residual values. These aircraft are typically older planes that are less in demand and have lower lease rates. In the fourth quarter of 2009, we recognized impairment charges in the amount of $52.9 million related to three older out-of-production aircraft. As of December 31, 2009, in addition to these three aircraft, we had identified 14 aircraft as being susceptible to failing the recoverability test. These 14 aircraft had an aggregate net book value of approximately $312 million at December 31, 2009. Management believes that the carrying values of these and all other aircraft are supported by the estimated future undiscounted cash flows expected to be generated by each aircraft.

 

As a result of the above conditions, three of our customers ceased operations during 2009; FlyLAL — Lithuanian Airlines, Myair.com S.p.A., and Globespan Airways Ltd. These customers operated nine of our aircraft. Eight of which were subsequently leased to other airlines and one remained available for lease at February 25, 2010.

 

There are lags between changes in current market conditions and their impact on our results, as contracts signed during times of higher lease rates currently remain in effect. Therefore, the current market conditions and their potential effect may not yet be fully reflected in our results. Although we continue to see lease rates contracting across most aircraft types, the rate of contraction has generally slowed as of February 25, 2010. Management monitors all lessees that are behind in lease payments and discusses relevant operational and financial issues facing the lessees with our marketing executives in order to determine the amount of rental income to recognize for past due amounts. Our customers make lease payments in advance and we generally recognize rental income only to the extent we have received payments or hold security deposits. During the fourth quarter of 2009, we restructured past due lease payments aggregating $35.1 million relating to eight customers operating 27 aircraft. At December 31, 2009, 12 customers operating 25 aircraft remained two or more months past due on $31.9 million of lease payments relating to some of those aircraft. Of this amount, we recognized $25.0 million in rental income through December 31, 2009, and as of February 25, 2010, we had collected $23.9 million thereof. In comparison, at December 31, 2008, 20 customers operating 73 aircraft were two or more months past due on $49.3 million of lease payments relating to some of those aircraft. Of this amount, we recognized $45.5 million in rental income through December 31, 2008.

 

Management also reviews all outstanding notes that are in arrears to determine whether we should reserve for or write off any portion of the notes receivable. In this process, management evaluates the collectability of each note and the value of the underlying collateral, if any, by discussing relevant operational and financial issues facing the lessees with our marketing executives. As of December 31, 2009, customers with $36.4 million carrying value of notes receivable were two months or more behind on principal and interest payments totaling $2.6 million.

 

Despite industry cyclicality and current stress, we remain optimistic about the long-term future of air transportation and, more specifically, the growing role that the leasing industry, and ILFC specifically, provides in facilitating the fleet transactions necessary to facilitate the growth of commercial air transport. At February 25, 2010, we have signed leases for all of our new aircraft deliveries through the end of 2010. Furthermore, our

contractual purchase commitments for future new aircraft deliveries through 2019 are at historic lows. We are working to solve our liquidity challenges as part of our strategic plan, to position ourselves to reap benefits from any opportunities that a down market may present.

 

Liquidity

 

As of the date of this report, due to the challenges facing our parent, AIG, the downgrades in our credit ratings by the rating agencies, and the recent turmoil in the credit markets, we are unable to access the commercial paper market and have limited access to unsecured debt markets and have borrowed the maximum amount under our senior revolving credit facilities. Therefore, we have recently funded our aircraft purchase commitments and maturing debt obligations and other contractual obligations through other methods, including secured financings and support from AIG.

 

At December 31, 2009, we had approximately $682 million available for the financing of new Airbus aircraft under our 2004 ECA facility. As a result of our current long-term debt ratings, under the terms of our 1999 and 2004 ECA facilities, we are required to segregate into accounts controlled by the security trustees of the ECA facilities security deposits, maintenance reserves, and rental payments received under the leases related to the aircraft funded under the facilities (segregated rental payments will be used to pay principal and interest on the outstanding debt). Segregated amounts totaled approximately $315 million at December 31, 2009. In addition, we need written consent from the security trustee of our 2004 ECA facility before we can fund future Airbus aircraft deliveries under the facility. We obtained consent for 19 of the 24 Airbus aircraft we purchased since March 17, 2009, when the security trustee’s consent became required. We financed the 19 aircraft under the facility during 2009, and subsequent to December 31, 2009, we obtained consent for and expect to finance the remaining five aircraft delivered in the fourth quarter of 2009 in March 2010.

 

We borrowed $3.9 billion from AIG Funding during 2009 to assist in funding our liquidity needs, including the repayment of our obligations under our $2.0 billion revolving credit agreement that matured on October 15, 2009. These term loans are secured by a portfolio of aircraft and other assets related to the pledged aircraft. See “Debt Financings — Loans from AIG Funding.” We also entered into secured financings with respect to two aircraft during the second quarter of 2009. Under our existing public debt indentures and bank loans, we and our subsidiaries are permitted to incur secured indebtedness totaling up to 12.5% of consolidated net tangible assets, as defined in such debt agreements, which is currently approximately $4.7 billion. Therefore, we can currently incur additional secured financings totaling approximately $800 million under these existing debt agreements, provided we receive any required consents from the FRBNY. Furthermore, it may be possible, subject to receipt of any required consents from AIG Funding, the FRBNY, and the lenders under our bank loans, for us to obtain secured financing without regard to the 12.5% consolidated net tangible asset limit referred to above (but subject to certain other limitations) by doing so through subsidiaries that qualify as non-restricted under our public debt indentures. We will need to seek relief from our bank lenders with regard to the 12.5% limitation. We cannot predict whether the banks, AIG Funding, or the FRBNY will consent to us incurring additional secured debt.

 

We are also currently pursuing potential aircraft sales which could aggregate up to $3.5 billion in proceeds. Proposed portfolios have been presented to potential buyers; some bids have been received and are being evaluated. In evaluating the bids we are balancing the need for funds with the long term value of holding aircraft and long term prospects for us. Significant uncertainties exist as to the aircraft comprising any actual sale portfolio, the sale price for the portfolio, and whether we can reach an agreement with terms acceptable to the buyers and us. If an agreement is reached, the transaction would also have to be approved by the FRBNY. Therefore, we cannot predict whether a sale of aircraft will occur. Because the current market for aircraft is depressed due to the economic downturn and limited availability of buyer financing, a sale would likely result in a realized loss. Based on the range of potential aircraft portfolio sales currently being explored, the potential for impairment or realized loss could be material to our results of operations for an individual period. The amount of potential loss would be dependent upon the specific aircraft sold, the sale price, the sale date and any other sale contingencies.

 

Because of the poor condition of current credit markets and AIG’s plans to explore alternative restructuring opportunities for us, we may not be able to obtain additional secured financing from third parties on favorable terms, if at all. We also may be unable to reach an agreement to sell a portfolio of our aircraft on terms acceptable to both

parties. Therefore, we may need to seek additional support from AIG, which is subject to the FRBNY’s consent. We cannot predict whether AIG can obtain the FRBNY’s consent to allow AIG to provide additional support to us.

 

Consideration of ILFC’s Ability to Continue as a Going Concern

 

Current Situation

 

As discussed in greater detail above under “Liquidity,” we are currently unable to access the commercial paper market and have limited access to unsecured debt markets and we cannot determine if the commercial paper market will be available to us again, or when we will be able to access the unsecured markets. As a result, we borrowed $3.9 billion from AIG Funding during 2009 to fund our liquidity needs and we are currently seeking secured financings, as permitted under our existing debt agreements.

 

Furthermore, as a subsidiary of AIG, we are subject to the covenants in the FRBNY Credit Agreement and our credit agreements with AIG Funding also contain restrictive covenants. The covenants in these credit agreements restrict, among other things, our ability to:

 

 

These covenants may affect our ability to operate and finance our business as we deem appropriate, including our ability to incur secured indebtedness or sell aircraft in order to meet our liquidity needs..

 

Management’s Plans

 

Because we cannot determine if the commercial paper market will be available to us or when the unsecured debt markets may become fully available to us again, we are currently seeking other ways to fund our aircraft purchase commitments and future maturing obligations.

 

We are currently seeking the following sources of funding, as discussed in greater detail above under “Liquidity”:

 

 

The FRBNY collateral pool is very large and consists of younger, in production aircraft. The FRBNY must approve all sales and secured borrowing, other than borrowing under the 2004 ECA facility. We cannot predict how this will impact the timing and conclusion of any potential sales.

 

If the above sources of liquidity are not sufficient to meet our contractual obligations as they come due over the next twelve months, we will seek additional funding from AIG, which funding would be subject to the consent of the FRBNY.

 

As stated in AIG’s annual report on Form 10-K for the period ended December 31, 2009, AIG intends to provide support to us through February 28, 2011, to the extent that secured financing, aircraft sales and other sources of funds are not sufficient to meet liquidity needs.

 

Management’s Assessment and Conclusion

 

In assessing our current financial position, liquidity needs and ability to meet our obligations as they come due, management made significant judgments and estimates with respect to the potential financial and liquidity effects of our risks and uncertainties, including but not limited to:

 

 

Based on AIG’s expressed intention to support us, its recent funding of $2.2 billion to us to repay our maturing debt, and management’s plans as described above, and after consideration of the risks and uncertainties of such plans, management believes we will have adequate liquidity to finance and operate our business and repay our obligations for at least the next twelve months.

 

It is possible that the actual outcome of one or more of management’s plans could be materially different or that one or more of management’s significant judgments or estimates about the potential effects of the risks and uncertainties could prove to be materially incorrect.

 

Our consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. These consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets, nor relating to the amounts and classification of liabilities that may be necessary should we be unable to continue as a going concern.

 

Our Relationship with AIG

 

AIG has experienced liquidity problems that began in the third quarter of 2008 and, as a result, it has entered into a series of transactions with the FRBNY and the U.S. Department of the Treasury.

 

The FRBNY Credit Agreement

 

As more fully described in AIG’s annual report on Form 10-K for the period ended December 31, 2009, the FRBNY Credit Agreement obligations are guaranteed by certain AIG subsidiaries and the obligations are secured by a pledge of certain assets of AIG and its subsidiaries. As a subsidiary of AIG, we are subject to covenants under the FRBNY Credit Agreement, including covenants that may, among other things, limit our ability to incur debt, encumber or sell our assets, enter into sale-leaseback transactions, make equity or debt investments in other parties and pay distributions and dividends. In addition, although we are not a guarantor of the FRBNY Credit Agreement and did not pledge any assets to secure AIG’s obligation under that agreement, in connection with our borrowings from AIG Funding, in order to receive the FRBNY’s consent to the loans we did guarantee the repayment of AIG’s obligations under the FRBNY Credit Agreement up to an amount equal to the aggregate outstanding balance of our term loans from AIG Funding. AIG is required to repay the FRBNY Credit Agreement primarily from proceeds on

sales of assets, including businesses. AIG is exploring divestiture opportunities for its non-core businesses and is exploring alternative restructuring opportunities for us.

 

AIG Going Concern Consideration

 

In connection with the preparation of its annual report on Form 10-K for the year ended December 31, 2009, AIG management assessed whether AIG has the ability to continue as a going concern. Based on the U.S. government’s continuing commitment, the agreements in principle and the other expected transactions with the FRBNY and the U.S. Department of the Treasury, AIG management’s plans to stabilize its businesses and dispose of certain assets, and after consideration of the risks and uncertainties to such plans, AIG management indicated in the AIG annual report on Form 10-K for the year ended December 31, 2009 that it believes that it will have adequate liquidity to finance and operate its businesses, execute its asset disposition plan and repay its obligations for at least the next twelve months. It is possible that the actual outcome of one or more of AIG management’s plans could be materially different, or that one or more of AIG management’s significant judgments or estimates about the potential effects of these risks and uncertainties could prove to be materially incorrect. If one of more of these possible outcomes is realized, AIG may need additional U.S. government support to meet its obligations as they come due. If AIG is not able to continue as a going concern it will have a significant impact on our operations, including limiting our ability to issue new debt and to receive additional support from AIG.

 

Debt Financings

 

We generally fund our operations, including aircraft purchases, through available cash balances, cash flows from operations, and debt financings. We borrow funds to purchase new and used flight equipment, make progress payments during aircraft construction and pay off maturing debt obligations. In the past these funds were borrowed principally on an unsecured basis from various sources and include both public debt and bank facilities. In 2009, these funds were primarily provided by AIG Funding and other secured financings. At December 31, 2009, we were in compliance in all material respects with the covenants in our debt agreements, including our financial covenants to maintain a maximum ratio of consolidated indebtedness to consolidated tangible net worth, a minimum fixed charge coverage ratio and a minimum consolidated tangible net worth.

 

During the year ended December 31, 2009, we borrowed $5.3 billion and $3.5 billion was provided by operating activities. The $5.3 billion borrowed included $1.1 billion borrowed under our 2004 ECA facility to fund Airbus aircraft purchases, $3.9 billion borrowed from AIG Funding to fund our other liquidity needs, including repaying our maturing debt obligations as they became due, and $0.3 billion of other financing arrangements. We had $336.9 million in cash and cash equivalents at December 31, 2009.

Our debt financing was comprised of the following at the following dates:

 

 

 

The above amounts represent the anticipated settlement of our currently outstanding debt obligations. Certain adjustments required to present currently outstanding hedged debt obligations have been recorded and presented separately on the balance sheet, including adjustments related to foreign currency hedging and interest rate hedging activities. We have eliminated the currency exposure arising from foreign currency denominated notes by hedging the notes through swaps. Foreign currency denominated debt is translated into US dollars using exchange rates as of each balance sheet date. The foreign exchange adjustment for the foreign currency denominated debt hedged with derivative contracts was $391.1 million and $338.1 million at December 31, 2009 and 2008, respectively. Composite interest rates and percentages of total debt at fixed rates reflect the effect of derivative instruments. Our lower composite interest rate at December 31, 2009, compared to December 31, 2008, is driven by a decrease in short-term interest rates.

 

ECA Financings

 

Export Credit Facilities:  We entered into ECA facilities in 1999 and 2004. The 2004 ECA facility is currently used to fund purchases of Airbus aircraft, while new financings are no longer available to us under the 1999 ECA facility. The loans made under the ECA facilities are used to fund a portion of each aircraft’s net purchase price.

 

In January 1999, we entered into the 1999 ECA facility to borrow up to $4.3 billion for the purchase of Airbus aircraft delivered through 2001. We used $2.8 billion of the amount available under this facility to finance purchases of 62 aircraft. Each aircraft purchased was financed by a ten-year fully amortizing loan with interest rates ranging from 5.753% to 5.898%. The loans are guaranteed by various European Export Credit Agencies. We have collateralized the debt by a pledge of the shares of a wholly-owned subsidiary that holds title to the aircraft financed under the facility. At December 31, 2009, 32 loans with an aggregate principal value of $146.1 million remained outstanding under the facility and the net book value of the related aircraft was $1.8 billion. Twenty-one of the loans outstanding under the 1999 ECA facility are scheduled to mature during 2010.

In May 2004, we entered into the 2004 ECA facility, which was amended in May 2009 to allow us to borrow up to $4.6 billion for the purchase of Airbus aircraft delivered through June 30, 2010. Funds become available under this facility when the various European Export Credit Agencies provide guarantees for aircraft based on a forward-looking calendar. The financing is for a ten-year fully amortizing loan per aircraft at an interest rate determined through a bid process. We have collateralized the debt by a pledge of the shares of a wholly-owned subsidiary that holds title to the aircraft financed under this facility. As of December 31, 2009, we had financed 66 aircraft using approximately $4 billion under this facility and approximately $2.9 billion was outstanding. The interest rates are either fixed or based on LIBOR. At December 31, 2009, the interest rates of the outstanding loans ranged from 0.45% to 4.71%. The net book value of the related aircraft was approximately $4.0 billion at December 31, 2009. As of February 25, 2010, we had approximately $682 million available under this facility.

 

Under the terms of our 1999 and 2004 ECA facilities, our current long-term debt ratings impose the following restrictions: (i) we must receive written consent from the security trustee before we can fund Airbus aircraft deliveries under the 2004 ECA facility; (ii) we must segregate all security deposits, maintenance reserves, and rental payments received under the leases of the aircraft financed under the 1999 and 2004 ECA facilities into separate accounts controlled by the security trustees (segregated rental payments will be used to pay principal and interest on the outstanding debt); and (iii) we must file individual mortgages on the aircraft funded under the 1999 and 2004 ECA facilities in the local jurisdictions in which the respective lessees operate. At December 31, 2009, we had segregated security deposits, maintenance reserves and rental payments aggregating approximately $315 million related to aircraft funded under the 1999 and 2004 ECA facilities. The segregated amounts will fluctuate with changes in deposits, maintenance reserves, and debt maturities related to the aircraft funded under the facilities.

 

Since March 17, 2009, when the security trustee’s consent became required to finance aircraft purchases under the 2004 ECA facility, we obtained consent for and financed all 19 Airbus aircraft delivered through September 30, 2009 under the facility, and subsequent to December 31, 2009, we obtained consent for and expect to finance all five Airbus aircraft delivered during the fourth quarter of 2009 in March 2010. To the extent the security trustee of the 2004 ECA facility does not allow us to fund future purchases of Airbus aircraft under the facility, we would have to locate other sources of financing to fund these purchases, as described in greater detail above under “Liquidity,” which would put additional strain on our liquidity.

 

Loans from AIG Funding

 

In March 2009 we entered into two demand note agreements aggregating $1.7 billion with AIG Funding in order to fund our liquidity needs. Interest on the notes was based on LIBOR with a floor of 3.5%. On October 13, 2009, we amended and restated the two demand note agreements, including extending the maturity dates, and entered into a new $2.0 billion credit agreement with AIG Funding. We used the proceeds from the $2.0 billion loan to repay in full our obligations under our $2.0 billion revolving credit facility that matured on October 15, 2009. On December 4, 2009, we borrowed an additional $200 million from AIG Funding to repay maturing debt. The amount was added to the principal balance of the new credit agreement. These loans, aggregating $3.9 billion, mature on September 13, 2013 and are due in full at maturity with no scheduled amortization. The loans bore interest at a rate of 3-month LIBOR plus 3.025%, which was subsequently raised to 6.025%, as discussed below. The funds for the loans were provided to AIG Funding by the FRBNY pursuant to the FRBNY Credit Agreement. In order to receive the FRBNY’s consent to the loans, we entered into guarantee agreements to guarantee the repayment of AIG’s obligations under the FRBNY Credit Agreement up to an amount equal to the aggregate outstanding balance of the loans.

 

These loans (and the related guarantees) are secured by (i) a portfolio of aircraft and all related equipment and leases, with an aggregate average appraised value as of September 30, 2009 of approximately $7.4 billion plus additional temporary collateral with an aggregate average appraised value as of September 30, 2009 of approximately $10 billion that will be released upon the perfection of certain security interests, as described below; (ii) any and all collection accounts into which rent, maintenance reserves, security deposits and other amounts owing are paid under the leases of the pledged aircraft; and (iii) the shares or other equity interests of certain subsidiaries of ours that may own or lease the pledged aircraft in the future. In the event the appraised value of the collateral held falls below certain levels, we will be forced either to prepay a portion of the term loans without penalty or premium, or to grant additional collateral.

We are also required to prepay the loans, without penalty or premium, upon (i) the sale of an aircraft (other than upon the sale or transfer to a co-borrower under the loans) in an amount equal to 75% of the net sale proceeds; (ii) the receipt of any hull insurance, condemnation or other proceeds in respect of any event of loss suffered by a pledged aircraft in an amount equal to 75% of the net proceeds received on account thereof; and (iii)  the removal of an aircraft from the collateral pool (other than in connection with the substitution of a non-pool aircraft for such removed aircraft in accordance with the terms of the loans) in an amount equal to 75% of the most recent appraised value of such aircraft. We are also required to repay the loans in full upon the occurrence of a change in control, which is defined in the loan agreements to include AIG ceasing to beneficially own 100% of our equity interests. We may voluntarily prepay the loans in part or in full at any time without penalty or premium.

 

The loans contain customary affirmative and negative covenants and include restrictions on asset transfers and capital expenditures. The loans also contain customary events of default, including an event of default under the loans if an event of default occurs under the FRBNY Credit Agreement. One event of default under the loans was the failure to perfect security interests, for the benefit of AIG Funding and the FRBNY, in certain aircraft pledged as collateral by December 1, 2009. We were unable to perfect certain of these security interests in a manner satisfactory to the FRBNY by December 1, 2009, and as a result entered into temporary waivers and amendments which (i) will allow us to release the temporary collateral of approximately $10 billion once we have completed the transfer of all the aircraft pledged as security to special purpose entities and perfected the security interests of all such aircraft for the benefit of AIG Funding and the FRBNY; (ii) required us to add certain aircraft leasing subsidiaries as co-obligors on the loans; and (iii) will require us to transfer pledged aircraft to special purpose entities within a prescribed time period (not less than three months from the date of notice) upon request, at any time, by AIG Funding (the “Transfer Mandate”). Pursuant to the temporary waiver and amendment, until all perfection requirements with regard to the pledged aircraft have been satisfied, the interest rate was raised to three-month LIBOR plus 6.025%, of which 3.0% is permitted to be paid-in-kind and is added to the principal balance of the loans. Additionally, if we do not comply with any Transfer Mandate within the prescribed time period, we will be in default under the loan agreements with AIG Funding and the interest rate may increase to three-month LIBOR with a 2% floor plus 9.025%. As of February 25, 2010, the FRBNY had not presented us with any Transfer Mandate. Within 30 days after our compliance with the perfection requirements for all of the pledged aircraft, including the transfer of all such aircraft to special purpose entities, a pool of aircraft with a 50% loan-to-value ratio will be selected by AIG Funding and the FRBNY from the pledged aircraft, and the additional temporary collateral with an aggregate appraised value of approximately $10 billion at September 30, 2009 will be released.

 

Other Secured Financing Arrangements

 

In May 2009, ILFC provided $39.0 million of subordinated financing to an entity, which we have determined is a Variable Interest Entity (“VIE”) of which we are the primary beneficiary. The primary beneficiary of a VIE is the party with the variable interest in the entity that absorbs the majority of the expected losses of the VIE, receives the majority of the expected residual returns of the VIE, or both. See Note M of Notes to Consolidated Financial Statements. Accordingly, we consolidate the entity into our consolidated financial statements. The entity used these funds and an additional $106.0 million borrowed from third parties to purchase an aircraft, which the entity leases to an airline. ILFC acts as servicer of the lease for the entity. The $106.0 million loan has two tranches. The first tranche is $82.0 million, fully amortizes over the lease term, and is non-recourse to ILFC. The second tranche is $24.0 million, partially amortizes over the lease term, and is guaranteed by ILFC. Both tranches of the loan are secured by the aircraft and the lease receivables. Both tranches have nine-year terms with interest rates based on LIBOR. At December 31, 2009, the interest rates on the $82.0 million and $24.0 million tranches were 3.385% and 5.085%, respectively. The entity entered into two interest rate cap agreements to economically hedge the related LIBOR interest rate risk in excess of 4.00%. At December 31, 2009, $100.6 million was outstanding and the net book value of the aircraft was $142.1 million.

 

In June 2009, we borrowed $55.4 million through a wholly-owned subsidiary that is considered a VIE and owns one aircraft leased to an airline. The loan is non-recourse to ILFC and the loan is secured by the aircraft and the lease receivables. The interest rate on the loan is fixed at 6.58%. At December 31, 2009, $52.5 million was outstanding and the net book value of the aircraft was $94.6 million.

Commercial Paper and Other Short-Term Debt

 

Commercial Paper: We have a $6.0 billion Commercial Paper Program and we had access to the FRBNY Commercial Paper Funding Facility (“CPFF”) from October 2008 through January 2009. As previously discussed under “Liquidity,” we are unable to issue new commercial paper with our current short-term debt ratings and we cannot determine if the commercial paper markets will be available to us again. At December 31, 2009, we have no commercial paper outstanding.

 

Other short-term financing: In April 2009, we entered into a $100.0 million 90-day promissory note agreement with a supplier in connection with the purchase of an aircraft. The interest rate was fixed at the annual rate of 5.00%. The note was paid in full on July 22, 2009, when it matured.

 

Public Bonds and Medium-Term Notes

 

Although legally available, debt issuance under our automatic shelf registration statement and our $7.0 billion Euro medium-term note programme is limited. The table below shows the maximum offerings available and amount outstanding under our sources of public debt:

 

 

 

 

At December 31, 2009, we had public bonds and medium-term notes in the amount of $16.6 million that were issued under prior registration statements. The interest rate on most of our public debt currently outstanding is effectively fixed for the terms of the notes.

 

Bank Debt

 

Revolving Credit Facilities:  We previously entered into three unsecured revolving credit facilities with an original group of 35 banks for an aggregate amount of $6.5 billion, consisting of a $2.0 billion tranche that expired and was paid in full in October 2009, a $2.0 billion tranche that expires in October 2010, and a $2.5 billion tranche that expires in October 2011. These revolving credit facilities provide for interest rates that vary according to the pricing option selected at the time of borrowing. Pricing options include a base rate, a rate ranging from 0.25% over LIBOR to 0.65% over LIBOR based upon utilization, or a rate determined by a competitive bid process with the banks. The credit facilities are subject to facility fees, currently 0.2% of amounts available. We are currently paying the maximum fees under the facilities. The fees are based on our current credit ratings and may decrease in the event of upgrades to our ratings. As of December 31, 2009, the maximum amount available of $4.5 billion under our active revolving credit facilities was outstanding and interest was accruing on the outstanding loans with interest rates based on LIBOR ranging from 0.91% to 0.93%. If AIG sells 51% or more of our equity interests without our lenders’ consent, it would be an event of default under our revolving credit facilities and would allow our lenders to declare our debt immediately due and payable.

 

Term Loans:  From time to time, we enter into funded bank financing arrangements. As of December 31, 2009, $0.6 billion was outstanding under these term loan agreements, which have varying maturities through February 2012. The interest rates are based on LIBOR with spreads ranging from 0.30% to 0.40%. At December 31, 2009, the interest rates ranged from 0.55% to 0.68%. If AIG sells 51% or more of our equity interests without our

lenders’ consent, it would be an event of default under our funded bank financing agreements and would allow our lenders to declare our debt immediately due and payable.

 

Subordinated Debt

 

In December 2005, we issued two tranches of subordinated debt totaling $1.0 billion. Both tranches mature on December 21, 2065, but each tranche has a different call option. The $600 million tranche has a call option date of December 21, 2010, and the $400 million tranche has a call option date of December 21, 2015. The tranche with the 2010 call option date has a fixed interest rate of 5.90% for the first five years, and the tranche with the 2015 call option date has a fixed interest rate of 6.25% for the first ten years. Each tranche has an interest rate adjustment if the call option for that tranche is not exercised. The new interest rate would be a floating rate, reset quarterly, based on the initial credit spread of 1.55% and 1.80%, respectively, plus the highest of (i) 3 month LIBOR; (ii) 10-year constant maturity treasury; and (iii) 30-year constant maturity treasury.

 

Derivatives

 

We employ a variety of derivative products to manage our exposure to interest rates risks and foreign currency risks. We enter into derivative transactions only to economically hedge interest rate risk and currency risk and not to speculate on interest rates or currency fluctuations. These derivative products include interest rate swap agreements, foreign currency swap agreements and interest rate cap agreements.

 

We had four foreign currency swaps that were not designated as hedges prior to April 1, 2007, and our interest rate cap agreements were not designated as hedges in 2009. At December 31, 2009, 2008 and 2007, all our interest rate swap and foreign currency swap agreements were designated as and accounted for as cash flow hedges and we had not designated our interest rate cap agreements as hedges.

 

When interest rate and foreign currency swaps are effective as cash flow hedges, they offset the variability of expected future cash flows, both economically and for financial reporting purposes. We have historically used such instruments to effectively mitigate foreign currency and interest rate risks. The effect of our ability to apply hedge accounting for the swaps is that changes in their fair values are recorded in other comprehensive income instead of in earnings each reporting period. As a result, reported net income will not be directly influenced by changes in interest rates and currency rates.

 

The counterparty to our interest rate swap and foreign currency swap agreements is AIGFP, a non-subsidiary affiliate. The swap agreements are subject to a bilateral security agreement and a master netting agreement, which would allow the netting of derivative assets and liabilities in the case of default under any one contract. Failure of the instruments or counterparty to perform under the derivative contracts would have a material impact on our results of operations and cash flows. The counterparty to our interest rate cap agreements is an independent third party with whom we do not have a master netting agreement. The net fair value of our derivatives was decreased by adjustments related to our counterparties’ credit risk and liquidity risk aggregating $4.0 million for the year ended December 31, 2009. The calculation of counterparties’ credit risks and liquidity risks aggregated $24.2 million and $19.8 million at December 31, 2009 and 2008, respectively.

 

Credit Ratings

 

The following table summarizes our current ratings and outlook by Fitch Ratings, Inc. (“Fitch”), Moody’s Investor Service, Inc. (“Moody’s”), and Standard & Poor’s, a division of the McGraw-Hill Companies, Inc. (“S&P”), the nationally recognized ratings agencies:

 

 

These credit ratings are the current opinions of the rating agencies. As such, they may be changed, suspended or withdrawn at any time by the rating agencies as a result of various circumstances including changes in, or unavailability of, information.

Our current long-term debt ratings impose the following restrictions under the 1999 and 2004 ECA facilities: (i) we need written consent from the security trustee before we can fund Airbus aircraft deliveries under the 2004 ECA facility; (ii) we must segregate all security deposits, maintenance reserves, and rental payments related to the aircraft financed under the 1999 and 2004 ECA facilities into separate accounts controlled by the security trustees (segregated rental payments will be used to pay principal and interest on the outstanding debt); and (iii) we must file individual mortgages on the aircraft funded under the facilities in the local jurisdictions in which the respective lessees operate.

 

While a ratings downgrade does not result in a default under any of our debt agreements, it would adversely affect our ability to issue unsecured debt, obtain new financing arrangements or renew existing arrangements, and would increase the cost of such financing arrangements.

 

The following table summarizes our contractual obligations at December 31, 2009.

 

Existing Commitments

 

 

Contingent Commitments

 

 

 

 

 

 

Variable Interest Entities

 

Our leasing and financing activities require us to use many forms of special purpose entities to achieve our business objectives and we have participated to varying degrees in the designs and formation of these special purpose entities. A majority of these entities are wholly-owned; we are the primary or only variable interest holder, we are the only decision maker and we guarantee all the activities of the entities. However, these entities meet the definition of a VIE because they do not have sufficient equity to operate without our subordinated financial support in the form of intercompany notes and loans which serve as equity. We have variable interest in other entities in which we have determined that we are the primary beneficiary, because by design we absorb the majority of the risks and rewards. Further, since we control and manage all aspects of the entities, the related aircraft are included in Flight equipment under operating leases and the related borrowings are included in Debt Financings on our Consolidated Balance Sheets.

 

In addition to the above entities ILFC has variable interests in ten entities to which we previously sold aircraft. The interests include debt financings, preferential equity interests, and in some cases providing guarantees to banks which had provided the secured senior financings to the entities. Each entity owns one aircraft. The individual financing agreements are cross-collateralized by the aircraft. We have determined that we are the primary beneficiary of these entities because we have exposure to the majority of the risks and rewards of these entities. We do not, however, have legal or operational control over and we do not own the assets nor are we directly obligated for the liabilities of these entities. As such, the assets and liabilities of these entities are presented separately on our Consolidated Balance Sheets. Assets in the amount of $79.7 million and $98.7 million and liabilities in the amount of $6.5 million and $10.7 million are included in our 2009 and 2008 Consolidated Balance Sheets and net expenses in the amounts of $7.2 million, $2.3 million, and $3.8 million are included in our Consolidated Statements of Income for the years ended December 31, 2009, 2008, and 2007, respectively, for these entities. We have a credit facility with these entities to provide financing up to approximately $13.6 million, of which approximately $8.4 million was borrowed at December 31, 2009. The maximum exposure to loss for these entities is $79.7 million, which is the total recorded asset balance of these entities.

 

Results of Operations

 

2009 Compared to 2008

 

Revenues from rentals of flight equipment increased 6.7% to $5,275.2 million for the year ended December 31, 2009, from $4,943.4 million for the year ended December 31, 2008. The number of aircraft in our fleet increased to 993 at December 31, 2009, compared to 955 at December 31, 2008. Revenues from rentals of flight equipment increased (i) $323.9 million due to the addition of new aircraft to our fleet after December 31, 2008, and aircraft in our fleet as of December 31, 2008 that earned revenue for a greater number of days during the year ended December 31, 2009 than during the year ended December 31, 2008; (ii) $76.3 million due to an increase in the number of leases containing overhaul provisions, resulting in an increase in the aggregate hours flown on which we collect overhaul revenue; and (iii) $7.0 million due to lower charges taken related to the early termination of six lease agreements in 2009 compared to ten lease agreements in 2008. These revenue increases were partially offset by (i) a $37.7 million decrease due to lower lease rates on aircraft in our fleet during both periods, that were re-leased or had lease rate changes between the two periods; (ii) a $25.8 million decrease in lost revenue relating to aircraft in transition between lessees, primarily resulting from repossessions of aircraft from airlines who filed for bankruptcy protection or ceased operations; (iii) a $14.8 million decrease related to aircraft in service during the year ended December 31, 2008, and sold prior to December 31, 2009; and (iv) a $2.9 million decrease due to a straight-line adjustment taken in 2008, which increased the 2008 lease revenue. Eight aircraft in our fleet were not subject to a signed lease agreement or a signed letter of intent at December 31, 2009, seven of which were subsequently leased.

 

In addition to leasing operations, we engage in the marketing of our flight equipment throughout the lease term, as well as the sale of third party owned flight equipment on a principal and commission basis. We incurred a

loss of $11.7 million from flight equipment marketing for the year ended December 31, 2009, compared to revenues of $46.8 million for the year ended December 31, 2008. The loss incurred for the year ended December 31, 2009, was due to renegotiated leases which converted three operating leases into sales-type leases. We sold nine aircraft, three of which were accounted for as sales-type leases, for the year ended December 31, 2009. In comparison, we sold 11 aircraft during the same period 2008, one of which was accounted for as a sales-type lease. Additionally, we sold one engine during the year ended December 31, 2008.

 

Interest and other revenue decreased to $58.2 million for the year ended December 31, 2009, compared to $98.3 million for the year ended December 31, 2008, due to (i) a $20.3 million decrease in interest income which was directly related to customers paying down principal balances of Notes receivable and Net investment in finance and sales-type leases during 2009 and a decrease in interest rates; (ii) a $15.1 million decrease in security deposits forfeitures related to nonperformance by customers; (iii) an $8.1 million decrease in settlement and sales of claims against bankrupt airlines; (iv) a $7.3 million decrease in revenues related to our consolidated noncontrolled VIEs; and (v) other minor decreases aggregating $3.9 million. The decreases were offset by (i) a $9.2 million increase in foreign exchange gains; and (ii) a $5.4 million increase in proceeds received in excess of book value related to a loss of an aircraft.

 

Interest expense decreased to $1,365.5 million in 2009 compared to $1,576.7 million in 2008 as a result of lower short-term interest rates and a decrease in average outstanding debt to $31.1 billion in 2009 compared to $31.5 billion in 2008. Our average composite interest rate decreased to 4.43% at December 31, 2009, from 4.83% at December 31, 2008.

 

Our composite borrowing rates fluctuated as follows from December 2006 to December 2009:

 

ILFC Composite Interest Rates and Prime Rates

 

 

The effect from derivatives, net of change in hedged items due to changes in foreign exchange rates was income of $21.5 million and expenses of $39.9 million for the years ended December 31, 2009 and 2008, respectively. The income effect for the year ended December 31, 2009, includes $9.7 million of gains on matured swaps compared to losses on matured swaps of $22.1 million for the year ended December 31, 2008. If hedge accounting treatment is not applied during the entire life of the derivative, or the hedge is not perfectly effective for some part of its life, a gain or loss will be realized at the maturity of the swap. See Note O of Notes to Consolidated Financial Statements.

Depreciation of flight equipment increased 5.1% to $1,959.4 million for the year ended December 31, 2009, compared to $1,864.7 million for the year ended December 31, 2008 due to the addition of new aircraft to our leased fleet, which increased the total cost of the fleet to $57.7 billion at December 31, 2009 from $55.4 billion at December 31, 2008.

 

Provision for overhauls increased to $347.0 million for the year ended December 31, 2009, compared to $264.6 million for the year ended December 31, 2008, due to (i) an increase in the number of leases with overhaul provisions; (ii) an increase in hours flown resulting in an increase the estimated future reimbursements; and (iii) an increase in actual and expected overhaul related expenses.

 

Selling, general and administrative expenses increased to $196.7 million for the year ended December 31, 2009, compared to $183.4 million for the year ended December 31, 2008, due to (i) a $10.2 million increase in salary and employee related expenses, including accrued and unpaid performance incentive and retention bonuses; (ii) a $9.4 million increase in operating expenses to support our growing fleet; and (iii) other minor increases aggregating $0.6 million. The increases were offset by (i) a $4.5 million decrease in write downs of notes receivable and (ii) a $2.4 million decrease in expenses related to our consolidated noncontrolled VIEs.

 

Other expenses for the year ended December 31, 2009, consisted of (i) $52.9 million in aircraft impairment charges on three older aircraft and (ii) a $7.5 million charge taken in the first quarter of 2009 related to an aircraft classified as aircraft held for sale and subsequently sold.

 

Other expenses for the year ended December 31, 2008, consisted of (i) a charge of $18.1 million related to a write down of a secured note to fair value (see Note N of Notes to the Consolidated Financial Statements) and (ii) a charge of $28.5 million related to a notes receivable secured by aircraft which became uncollectible when Alitalia filed for bankruptcy protection and rejected the leases of the aircraft securing the note. The charge reflects the difference between the fair market value of the aircraft received and the net carrying value of the note.

 

Our effective tax rate for the years ended December 31, 2009 and 2008 remained relatively constant. Our effective tax rate continues to be impacted by minor permanent items and interest accrued on uncertain tax positions and prior period audit adjustments. Our reserve for uncertain tax positions increased by $44.3 million primarily due to the continued uncertainty of tax benefits related to the Foreign Sales corporation and Extraterritorial Income regimes, the benefits of which, if realized, would have a significant impact on our effective tax rate.

 

In 2002 and 2003 we participated in certain tax planning activities with our parent, AIG and related entities, which provided certain tax and other benefits to the AIG consolidated group. As a result of our participation, ILFC’s liability to pay tax under our tax sharing agreement increased. AIG agreed to defer $245.0 million of this liability until 2007 ($160.0 million) and 2010 ($85.0 million). The liability is recorded in Tax benefit sharing payable to AIG on our Consolidated Balance Sheets.

 

Accumulated other comprehensive loss was $138.2 million and $168.1 million at December 31, 2009 and 2008, respectively. Fluctuations in Accumulated comprehensive income are primarily due to changes in market values of cashflow hedges. See Note G of Notes to the Consolidated Financial Statements.

 

Results of Operations

 

2008 Compared to 2007

 

Revenues from rentals of flight equipment increased 7.8% to $4,943.4 million in 2008 from $4,587.6 million in 2007. The number of aircraft in our fleet increased to 955 at December 31, 2008, compared to 900 at December 31, 2007. Revenues from rentals of flight equipment increased (i)  $415.9 million due to the addition of aircraft to our fleet that earned revenue during all or part of the year ended December 31, 2008, compared to no or partial earned revenue during 2007; (ii)  $29.7 million due to higher lease rates for certain aircraft that were in our fleet during both periods; and (iii) a $2.9 million straight-line rent adjustment. The increases were partially offset by (i) a $38.8 million decrease related to aircraft in service during the period ended December 31, 2007, and sold prior to December 31, 2008; (ii) a $24.1 million decrease due to lost revenue relating to aircraft in transition between lessees, primarily resulting from repossessions of aircraft from airlines who filed for bankruptcy protection or ceased operations; (iii) a $16.7 million decrease due to a decrease in the number of hours flown, on which we collect

overhaul revenue; and (iv) a $13.1 million charge related to the early termination of ten ATA lease agreements. We had two aircraft in our fleet that were not subject to a signed lease agreement or a signed letter of intent at December 31, 2008, one of which was subsequently leased.

 

In addition to leasing operations, we engage in the marketing of our flight equipment throughout the lease term, as well as the sale of third party owned flight equipment on a principal and commission basis. Revenues from flight equipment marketing increased to $46.8 million for the year ended December 31, 2008, compared to $30.6 million for the year ended December 31, 2007, due to an increase in the number of, and the different types of, flight equipment sold in 2008 compared to 2007. During the year ended December 31, 2008, we sold 11 aircraft, one of which was accounted for as a sales-type lease. During year ended December 31, 2007, we sold nine aircraft, one of which was accounted for as a finance lease and one of which was converted from an operating lease to a sales-type lease. We also sold one engine during each of the years ended December 31, 2008 and 2007.

 

Interest and other revenue decreased to $98.3 million for the year ended December 31, 2008, compared to $111.6 million for the year ended December 31, 2007, due to (i) a $21.6 million decrease in settlements or sale of claims against bankrupt airlines; (ii) an $11.5 million decrease in foreign exchange gains; and (iii) lower management and other miscellaneous fees aggregating a decrease of $10.6 million. These decreases were offset by (i) an $18.8 million increase in deposit forfeitures for nonperformance by customers and (ii) an $11.6 million increase in interest revenues on Notes receivables and finance and sales-type leases.

 

Interest expense decreased to $1,576.7 million for the year ended December 31, 2008, compared to $1,612.9 million for the year ended December 31, 2007, as a result of lower short-term interest rates offset by (i) an increase in average debt outstanding (excluding the effect of debt discount and foreign exchange adjustments), primarily borrowed to finance aircraft acquisitions, to $31.5 billion in 2008 compared to $29.7 billion in 2007 and (ii)  a $29.3 million put fee related to bonds issued in 1997. Our average composite interest rate decreased to 4.84% in 2008 from 5.20% in 2007.

 

The Effect from derivatives, net of change in hedged items due to changes in foreign exchange rates was expenses of $39.9 million and $5.3 million for the years ended December 31, 2008 and 2007, respectively. The 2007 income effect includes a $16.0 million expense from derivatives with no hedge accounting treatment, net of foreign exchange gain or loss on the economically hedged item. We began applying hedge accounting for all our swap contracts at the beginning of the second quarter of 2007. The 2008 income effect includes $22.1 million of losses on matured swaps. If hedge accounting treatment is not applied during the entire life of the derivative, or the hedge is not perfectly effective for some part of its life, a gain or loss will be realized at the maturity of the swap. See Note O of Notes to Consolidated Financial Statements.

 

Depreciation of flight equipment increased 7.4% to $1,864.7 million for the year ended December 31, 2008, compared to $1,736.3 million for the year ended December 31, 2007 due to the addition of new aircraft to our leased fleet, which increased the total cost of the fleet to $55.4 billion in 2008 from $52.2 billion in 2007.

 

Provision for overhauls decreased to $264.6 million for the year ended December 31, 2008, compared to $290.1 million for the year ended December 31, 2007, due to (i) a decrease in the aggregate number of hours flown, on which we collect overhaul revenue, which results in a decrease in the estimated future reimbursements and (ii) a decrease in actual and expected overhaul related expenses.

 

Selling, general and administrative expenses increased to $183.4 million for the period ended December 31, 2008, compared to $152.3 million for the year ended December 31, 2007, due to (i) a $21.5 million increase in employee-related expenses and (ii) a $13.8 million increase in operating expenses to support our growing fleet. The increases were offset by minor savings aggregating $4.2 million.

 

Other expenses for the year ended December 31, 2008, consisted of (i) a charge of $18.1 million related to a write-down of a secured note to fair value (see Note N of Notes to the Consolidated Financial Statements) and (ii) a charge of $28.5 million related to a notes receivable secured by aircraft which became uncollectible when Alitalia filed for bankruptcy protection and rejected the leases of the aircraft securing the note. The charge reflects the difference between the fair market value of the aircraft received and the net carrying value of the note.

 

Our effective tax rate for the year ended December 31, 2008, increased to 35.8% in 2008 from 33.9% in 2007. The increase is primarily due to Internal Revenue Service (“IRS”) audit and interest adjustments related to 2007 and

previous tax years recorded in 2008. Our effective tax rate continues to be impacted by minor permanent items and interest accrued on uncertain tax positions and prior period audit adjustments. Our reserve for uncertain tax positions increased by $51.0 million due to the continued uncertainty of tax benefits related to the Foreign Sales corporation and Extraterritorial Income regimes, the benefits of which, if realized, would have a significant impact on our effective tax rate.

 

In 2002 and 2003 we participated in certain tax planning activities with our parent, AIG and related entities, which provided certain tax and other benefits to the AIG consolidated group. As a result of our participation, ILFC’s liability to pay tax under our tax sharing agreement increased. AIG agreed to defer $245.0 million of this liability until 2007 ($160.0 million) and 2009 ($85.0 million). The liability is recorded in Tax benefit sharing payable to AIG on the 2008 Consolidated Balance Sheet.

 

Accumulated other comprehensive (loss) income was $(168.1) million and $(106.2) million at December 31, 2008 and 2007, respectively. Fluctuations in Accumulated other comprehensive income are primarily due to changes in market values of cashflow hedges. See Note G of Notes to the Consolidated Financial Statements.

 

Critical Accounting Policies and Estimates

 

Management’s 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 GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue, depreciation, overhaul reserves, and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The results 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 and conditions.

 

We believe the following critical accounting policies, can have a significant impact on our results of operations, financial position and financial statement disclosures, and may require subjective and complex estimates and judgments.

 

Lease Revenue: We lease flight equipment principally under operating leases and report rental income ratably over the life of the lease. The difference between the rental income recorded and the cash received under the provisions of the lease is included in Lease receivables and other assets on our Consolidated Balance Sheets. Past-due rentals are recognized on the basis of management’s assessment of collectibility. Management monitors all lessees that are behind in lease payments and discusses relevant operational and financial issues facing the lessees with our marketing executives in order to determine the amount of rental income to recognize for past due amounts. Our customers make lease payments in advance and we generally recognize rental income only to the extent we have received payments or hold security deposits. In certain cases, leases provide for additional rentals based on usage. The usage may be calculated based on hourly usage or on the number of cycles operated, depending on the lease contract. A cycle is defined as one take-off and landing. The usage is typically reported monthly by the lessee. Rentals received, but unearned under the lease agreements, are recorded in Rentals received in advance on our Consolidated Balance Sheets until earned. Lease revenues from the rental of flight equipment have been reduced by payments received directly by us or by our customers from the aircraft and engine manufacturers.

 

Initial Indirect Costs: We treat as period cost internal and other costs incurred in connection with identifying, negotiating, and delivering aircraft to our lessees. Amounts paid by us to lessees or other parties in connection with the lease transactions are capitalized and amortized as a reduction to lease revenue over the lease term.

 

Flight Equipment Marketing: Flight equipment marketing consists of revenue generated from the sale of flight equipment and commissions generated from leasing and sales of managed aircraft. Flight equipment sales are recorded when substantially all of the risks and rewards of ownership have passed to the new owner. Provisions for retained lessee obligations are recorded as reductions to Flight equipment marketing at the time of the sale.

Provision for Overhauls: Under the provisions of many leases, we receive overhaul rentals based on the usage of the aircraft. For certain airframe and engine overhauls, the lessee is reimbursed for costs incurred up to, but not exceeding, related overhaul rentals paid by the lessee for usage of the aircraft.

 

Overhaul rentals are included under the caption Rental of flight equipment in our Consolidated Statements of Income. We provide a charge to operations for estimated future reimbursements at the time the overhaul rentals are paid by the lessee. The charge is based on overhaul rentals received and the estimated reimbursements during the life of the lease. The historical payout rate is subject to significant fluctuations. Using its judgment, management periodically evaluates the appropriateness of the reserve for these reimbursements and its reimbursement rate, and then adjusts the provision for overhauls accordingly. This evaluation requires significant judgment. If the reimbursements are materially different than our estimates, there will be a material impact on our results of operations.

 

Flight Equipment: Flight equipment under operating leases is stated at cost. Purchases, major additions and modifications and interest on deposits during the construction phase are capitalized. The lessee provides and pays for normal maintenance and repairs, airframe and engine overhauls and compliance with return conditions of flight equipment returned from lease. We generally depreciate passenger aircraft, including those acquired under capital leases, using the straight-line method over a 25-year life from the date of manufacture to a 15% residual value. For freighter aircraft, depreciation is computed on the straight-line basis to a zero residual value over its useful life of 35 years. When an aircraft is out of production, management evaluates the residual value of the aircraft type, and depreciates the aircraft using the straight-line method over a 25-year life from the date of manufacture to an established residual value for each aircraft type. Due to the significant cost of aircraft carried in Flight equipment under operating leases on our Consolidated Balance Sheets, any change in the assumption of useful life or residual values for all aircraft could have a significant impact on our results of operations.

 

At the time assets are retired or sold, the cost and accumulated depreciation are removed from the related accounts and the difference, net of proceeds, is recorded as a gain or loss.

 

Management evaluates quarterly the need to perform a recoverability assessment as required under GAAP and performs a recoverability assessment of all aircraft in our fleet at least annually. An assessment is performed whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. The undiscounted cash flows consist of cash flows from currently contracted leases, future projected lease rates and estimated residual or scrap values for each aircraft. Management is very active in the industry and develops the assumptions used in the recoverability analysis based on its knowledge of active lease contracts, current and future expectations of the global demand for a particular aircraft type and historical experience in the aircraft leasing market and aviation industry, as well as information received from third party industry sources. The factors considered in estimating the undiscounted cash flows are impacted by changes in future periods due to changes in contracted lease rates, economic conditions, technology, airline demand for a particular aircraft type and many of the risk factors discussed in Item 1A. “Risk Factors.” In the event that an aircraft does not meet the recoverability test, the aircraft will be recorded at fair value in accordance with our Fair Value Policy resulting in an impairment charge. Our Fair Value Policy is described below under “— Fair Value Measurements.”

 

We recorded impairment charges related to three aircraft in the fourth quarter of 2009. In monitoring the aircraft in our fleet for impairment charges, we identify those aircraft that are most susceptible to failing the recoverability assessment and monitor those aircraft more closely, which may result in more frequent recoverability assessments. The recoverability of these aircraft is more sensitive to changes in contractual cash flows, future cash flow estimates and residual values. These aircraft are typically older planes that are less in demand and have lower lease rates. As of December 31, 2009, we have, in addition to the three aircraft mentioned above, identified 14 aircraft as being susceptible to failing the recoverability test. These aircraft had a net book value of approximately $312 million at December 31, 2009. Management believes that the carrying value of these aircraft is supported by the estimated future undiscounted cash flows expected to be generated by each aircraft.

 

Derivative Financial Instruments: We employ a variety of derivative instruments to manage our exposure to interest rate risks and foreign currency risks. Accounting for derivatives is very complex. All derivatives are recognized on the balance sheet at their fair value. We obtain the values on a quarterly basis from AIG. When hedge treatment is achieved, the changes in market values related to the effective portion of the derivatives are recorded in

other comprehensive income or in income, depending on the designation of the derivative as a cash flow hedge or a fair value hedge. The ineffective portion of the derivative contract is recorded in income. At designation of the hedge, we choose a method of effectiveness assessment, which we must use for the life of the contract. We use the “hypothetical derivative method” when we assess effectiveness. The calculation involves setting up a hypothetical derivative that mirrors the hedged item, but has a zero-value at the hedge designation date. The cumulative change in market value of the actual derivative instrument is compared to the cumulative change in market value of the hypothetical derivative. The difference is the calculated ineffectiveness and is recorded in income.

 

Fair Value Measurements: Fair value is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We measure the fair value of derivative assets and liabilities on a recurring basis. Our derivatives are not traded on an exchange and are inherently more difficult to value. AIG provides us the recurring valuations of our derivative instruments. AIG has established and documented a process for determining fair values. AIG’s valuation model includes a variety of observable inputs, including contractual terms, interest rate curves, foreign exchange rates, yield curves, credit curves, measures of volatility, and correlations of such inputs.

 

We also measure the fair value of certain assets and liabilities on a non-recurring basis, when GAAP requires the application of fair value, including events or changes in circumstances that indicate that the carrying amounts of assets may not be recoverable. These assets include aircraft and notes receivable. Liabilities include Asset Value Guarantees. We principally use the income approach to measure the fair value of these assets and liabilities. The income approach is based on the present value of cash flows from contractual lease agreements and projected future lease payments, including contingent rentals, net of expenses, which extend to the end of the aircraft’s economic life in its highest and best use configuration, as well as a disposition value based on expectations of market participants.

 

Income Taxes: We are included in the consolidated federal income tax return of AIG. Our tax provision is calculated on a separate return basis, adjusted to give recognition to the effects of net operating losses, foreign tax credits and the benefit of the Foreign Sales Corporation and Extraterritorial Income Exclusion provisions of the Internal Revenue Code to the extent they are currently realizable in AIG’s consolidated return. To the extent the benefit of a net operating loss is not utilized in AIG’s tax return, AIG will reimburse us upon the expiration of the loss carry forward period as long as we are still included in AIG’s consolidated federal tax return and the benefit would have been utilized if we had filed a separate consolidated federal income tax return. We calculate our provision using the asset and liability approach. This method gives consideration to the future tax consequences of temporary differences between the financial reporting basis and the tax basis of assets and liabilities based on currently enacted tax rates. Deferred tax liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

New Accounting Pronouncements

 

Recent Accounting Pronouncements:

 

We adopted the following accounting standards during 2009:

 

In December 2007, the FASB issued an accounting standard that changed the accounting for business combinations.

 

In December 2007, the FASB issued an accounting standard that changed the classification of non-controlling (i.e., minority) interests in the consolidated financial statements.

 

In March 2008, the FASB issued an accounting standard that requires enhanced disclosures about derivative instruments and hedging activities.

 

In December 2008, the FASB issued an accounting standard related to employers’ disclosures about post-retirement benefit plan assets.

 

In December 2008, the FASB issued an accounting standard that amends and expands the disclosure requirements regarding transfers of financial assets and a company’s involvement with VIEs.

In April 2009, the FASB issued an accounting standard that requires interim disclosures about fair value of financial instruments.

 

In April 2009, the FASB issued an accounting standard related to the recognition and presentation of other-than-temporary impairments.

 

In April 2009, the FASB issued an accounting standard related to determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly.

 

In May 2009, the FASB issued an accounting standard that requires disclosure of the date through which a company evaluated the need to disclose events that occurred subsequent to the balance sheet date and whether that date represents the date the financial statements were issued or were available to be issued.

 

In June 2009, the FASB issued an accounting standard related to the establishment of FASB Accounting Standards Codification (“ASC”).

 

In August 2009, the FASB issued an accounting standards update to clarify how the fair value measurement principles should be applied when measuring liabilities carried at fair value.

 

Future Application of Accounting Standards:

 

In June 2009, the FASB issued an accounting standard related to accounting for transfers of financial assets.

 

In June 2009, the FASB issued an accounting standard related to the consolidation of VIEs.

 

For further discussion of these recent accounting standards and their application to us, see Note B of Notes to Consolidated Financial Statements.

 

Measuring potential losses in fair values has recently become the focus of risk management efforts by many companies. Such measurements are performed through the application of various statistical techniques. One such technique is Value at Risk (“VaR”), a summary statistical measure that uses historical interest rates and foreign currency exchange rates and equity prices and estimates the volatility and correlation of these rates and prices to calculate the maximum loss that could occur over a defined period of time given a certain probability.

 

We believe that statistical models alone do not provide a reliable method of monitoring and controlling market risk. While VaR models are relatively sophisticated, the quantitative market risk information generated is limited by the assumptions and parameters established in creating the related models. Therefore, such models are tools and do not substitute for the experience or judgment of senior management.

 

We are exposed to market risk and the risk of loss of fair value and possible liquidity strain resulting from adverse fluctuations in interest rates and foreign exchange prices. We statistically measure the loss of fair value through the application of a VaR model on a quarterly basis. In this analysis the net fair value of our operations is determined using the financial instrument assets and other assets and liabilities. This includes tax adjusted future flight equipment lease revenues and financial instrument liabilities, which includes future servicing of current debt. The estimated impact of current derivative positions is also taken into account.

 

We calculate the VaR with respect to the net fair value by using historical scenarios. This methodology entails re-pricing all assets and liabilities under explicit changes in market rates within a specific historical time period. In this case, the most recent three years of historical information for interest rates and foreign exchange rates were used to construct the historical scenarios at December 31, 2009 and 2008. For each scenario, each financial instrument is re-priced. Scenario values for our operations are then calculated by netting the values of all the underlying assets and liabilities. The final VaR number represents the maximum adverse deviation in net fair market value incurred by these scenarios with 95% confidence (i.e., only 5% of historical scenarios show losses greater than the VaR figure). A one month holding period is assumed in computing the VaR figure. The following table presents the average, high and low VaRs on a combined basis and of each component at market risk for our operations with respect to its fair

value for the periods ended December 31, 2009 and 2008. The VaR decreased, despite the year-to-year growth in lease income, primarily due to significant decreases in yield volatilities.

 

ILFC Market Risk

 

 

 

The response to this Item is submitted as a separate section of this report.

 

 

None.

 

(A) Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Securities and Exchange Commission. Such information is accumulated and communicated to our management, including the Acting Chief Executive Officer, President and Chief Operating Officer and the Vice Chairman and Chief Financial Officer (collectively the “Certifying Officers”), as appropriate, to allow timely decisions regarding required disclosure. Our management, including the Certifying Officers, recognizes that any set of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

 

We have evaluated, under the supervision and with the participation of management, including the Certifying Officers, the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as of the end of the year covered by this annual report. Based on that evaluation, our Certifying Officers have concluded that our disclosure controls and procedures were effective as of December 31, 2009.

 

(B) Management’s Report on Internal Control over Financial Reporting

 

Management of ILFC is responsible for establishing and maintaining adequate internal control over financial reporting. ILFC’s internal control over financial reporting is a process, under the supervision of the Certifying Officers, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of ILFC’s financial statements for external purposes in accordance with GAAP.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

 

ILFC management, including the Certifying Officers, conducted an assessment of the effectiveness of ILFC’s internal control over financial reporting as of December 31, 2009 based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). ILFC management has concluded that, as of December 31, 2009, ILFC’s internal control over financial reporting was effective based on the criteria in Internal Control — Integrated Framework issued by the COSO.

This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange commission that permit us to provide only management’s report in this annual report.

 

Variable Interest Entities

 

We have consolidated into our Consolidated Financial Statements, financial information related to certain Variable Interest Entities (“VIEs”) over which we do not have operational control. The assets and liabilities are presented separately on our Consolidated Balance Sheets. Our assessment of disclosure controls and procedures, as described above, includes those VIEs. Each of these VIEs has a discrete number of assets and liabilities and we, as lender and guarantor to the VIEs, have been provided sufficient information to conclude that our procedures with respect to these VIEs are effective in providing reasonable assurance that the information required to be disclosed by us relating to these entities is reconciled, processed, summarized and reported within the periods specified by the Securities and Exchange Commission. However, management has been unable to assess the effectiveness of internal controls at VIEs over which we do not have operational control due to our inability to dictate or modify the controls over financial reporting of those entities, or to assess those controls.

 

(C) Changes in Internal Control Over Financial Reporting

 

There have been no changes in our internal controls over financial reporting during the quarter ended December 31, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Subsequent to December 31, 2009, we had a change in our Certifying Officers due to the retirement of our Chief Executive Officer, Steven F. Udvar-Hazy, on February 5, 2010. John L. Plueger, formerly our President and Chief Operating Officer, has been named Acting Chief Executive Officer, President and Chief Operating Officer and is signing this report on Form 10-K as the Principal Executive Officer.

 

None.

 

Aggregate fees for professional services rendered to us by PricewaterhouseCoopers LLP (“PwC”) for the years ended December 31, 2009 and 2008, were:

 

 

 

 

 

AIG’s audit committee approves all audit and non-audit services rendered by PwC.

 

(a)(1) and (2): Financial Statements and Financial Statement Schedule: The response to this portion of Item 15 is submitted as a separate section of this report.

 

(a)(3) and (b): Exhibits: The response to this portion of Item 15 is submitted as a separate section of this report.

INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES

 

FORM 10-K

Items 8, 15(a), and 15(b)

 

INDEX OF CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE

 

The following consolidated financial statements of the Company and its subsidiaries required to be included in Item 8 are listed below:

 

 

The following financial statement schedule of the Company and its subsidiaries is included in Item 15(a)(2):

 

 

 

All other financial statements and schedules not listed have been omitted since the required information is included in the consolidated financial statements or the notes thereto, or is not applicable or required.

 

The following exhibits of the Company and its subsidiaries are included in Item 15(b):

 

 

To The Shareholders and Board of Directors

of International Lease Finance Corporation:

 

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders’ equity and cash flows present fairly, in all material respects, the consolidated financial position of International Lease Finance Corporation, a wholly-owned subsidiary of American International Group, Inc. (“AIG”), and its subsidiaries (the “Company”) at December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As discussed in Note A, the Company is dependent upon securing additional sources of financing and the continued financial support of AIG to meet its obligations as they come due.

 

/s/ PricewaterhouseCoopers LLP

Los Angeles, California

 

February 28, 2010

INTERNATIONAL LEASE FINANCE CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share and per share amounts)