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, 2010

 

OR

 

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o  NO x

 

As of June 30, 2010 and March 9, 2011, 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

 

2010 FORM 10-K ANNUAL REPORT

 

 

TABLE OF CONTENTS

 

 

 

General

 

International Lease Finance Corporation’s (the “Company,” “ILFC,” “management,” “we,” “our,” “us”) primary business operation is to acquire new commercial jet aircraft from aircraft manufacturers and other parties and lease those aircraft to airlines throughout the world. We also 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. 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, 2010, we owned 933 jet aircraft, had four additional aircraft in the fleet classified as finance and sales-type leases and provided fleet management services for 97 aircraft. See “Item 2. Properties — Flight Equipment.” At December 31, 2010, we had contracted with the Boeing Company (“Boeing”) and Airbus S.A.S. (“Airbus”) to purchase 115 new aircraft, all negotiated in U.S. dollars, for delivery through 2019 with an estimated purchase price of $13.5 billion. See “Item 2. Properties — Commitments.” In the first quarter of 2011, we signed a memorandum of understanding to purchase 75 A320neos and 25 A321neos from Airbus, which will replace our previous A380 commitments, and a purchase agreement for 33 737-800 aircraft from Boeing. The estimated aggregate purchase price for the 133 aircraft is approximately $7.5 billion and the aircraft will deliver through 2019.

 

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.

 

We typically finance the purchase of aircraft through available cash balances, internally generated funds, including aircraft sales, and debt financings. At times, we engage in financing transactions for specific aircraft. Management accesses the capital markets for funds at times and on terms and conditions considered appropriate.

 

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. In September 2008, liquidity issues resulted in AIG seeking and receiving governmental support through a credit facility from the Federal Reserve Bank of New York (the “FRBNY Credit Facility”) and Troubled Asset Relief Program (“TARP”) funding from the United States Department of the Treasury (the “Department of the Treasury”). On January 14, 2011, AIG was recapitalized and the FRBNY Credit Facility was repaid and terminated through a series of transactions that resulted in the Department of the Treasury becoming AIG’s majority shareholder with ownership of approximately 92% of AIG’s outstanding common stock. AIG understands that, subject to market conditions, the Department of the Treasury intends to dispose of its ownership interest in AIG over time. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Result of Operations — Our Relationship with AIG.”

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”), rental revenues are recognized ratably over the lease term, as they are earned. Our aircraft under operating leases are included as Flight equipment under operating leases on our Consolidated Balance Sheets and are depreciated to an estimated residual 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 recognize interest revenues over the lease term in a manner that produces a constant rate of return over the life of the lease. At December 31, 2010, we accounted for 933 aircraft as operating leases and four 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. We recognize overhaul rentals received as revenue net of estimated overhaul reimbursements in the caption Rental of flight equipment in our Consolidated Statements of Operations. Except as disclosed above, we generally do not contribute to the cost of overhauls when we do not receive overhaul rentals.

 

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 its return. 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 certain leases that were in effect at March 11, 2005, and these hedges expired in 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 party.

 

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 2010, four of our lessees filed for bankruptcy protection or ceased operations. These customers operated 19 of our aircraft, of which 15 were leased from us and four were subleased from another one of our customers. As of March 4, 2011, 14 of these aircraft had been leased to other airlines, the four aircraft that were subleased remained on lease to the sublessor airline, and one aircraft had been sold. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview — Aircraft Industry and Sources of Revenue.”

 

Flight Equipment Marketing and Aircraft Sales

 

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 on disposition of leased aircraft is included in the caption Flight equipment marketing and gain on aircraft sales in our Consolidated Statements of Operations.

 

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, leasing companies, 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 operations. 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 Operations.

 

Financing/Source of Funds

 

We purchase new aircraft directly from manufacturers and used aircraft from airlines and other owners. We have generally financed our operations, including aircraft purchases, through available cash balances, internally generated funds, including aircraft sales, and debt financings. In September 2008, we became unable to issue

unsecured debt and, in 2009, we borrowed approximately $3.9 billion from AIG Funding Inc., a subsidiary of our parent, to fulfill our liquidity needs in excess of the cash flows generated by our operations. In 2010, we regained access to the debt markets and issued approximately $9.8 billion of secured and unsecured debt. We used a portion of the proceeds to repay the loans from AIG Funding, which allowed us to release approximately $10 billion of excess aircraft collateral previously pledged as security to AIG Funding. The new debt also resulted in extended and varying maturity dates for our debt. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity.”

 

Customers

 

Each airline and its revenues are classified within the geographical area that represents the airline’s principal place of business for the years indicated.

 

At December 31, 2010, 2009 and 2008, we leased aircraft to customers in the following regions:

 

 

 

Revenues from rentals of flight equipment to foreign airlines were $4.4 billion in 2010, $4.6 billion in 2009, and $4.4 billion in 2008, comprising 93.6%, 92.9%, and 93.0%, respectively, of total revenues from rentals of flight equipment. The following table sets forth the dollar amount and percentage of total revenues from rentals of flight equipment attributable to the indicated geographic areas based on each airline’s principal place of business for the years indicated:

 

 

 

Lease revenues from the rental of flight equipment have been reduced by payments received by our customers from the aircraft and engine manufacturers.

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 marketplace 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 their regulations, the DOC and the 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.

 

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which effects comprehensive changes to the regulation of financial services in the United States and will subject AIG to substantial additional federal regulation, was signed into law. The new legislation provides two scenarios under which the Board of Governors of the Federal Reserve System (the “FRB”) could become AIG’s regulator: (i) if AIG is recognized as a “savings and loan holding company” as defined by the Home Owners’ Loan Act (HOLA) and/or (ii) if the newly created risk regulator — the Financial Stability Oversight Council — designates AIG as a company whose material financial distress, or whose nature, scope, size, scale, concentration, interconnectedness or mix of activities, could pose a threat to the financial stability of the United States. If AIG becomes subject, as a savings and loan holding company, to the examination, enforcement and supervisory authority of the FRB, the FRB would have authority to impose capital requirements on AIG and its subsidiaries. We cannot predict how the FRB will exercise potential general supervisory authority over AIG subsidiaries.

 

Employees

 

We operate in a capital intensive rather than a labor intensive business. As of December 31, 2010, we had 194 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 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. Our Vice Chairman and President is subject to the imposed limitations and we have three other members of our senior management team who will be subject to the limitations in 2011.

 

During the year ended December 31, 2010, certain members of our senior management team left ILFC; we have been able to attract well qualified replacements.

 

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 party 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 listed in U.S. dollars 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 policies

include customary exclusions such as physical damage to aircraft hulls caused by dirty bombs, bio-hazardous materials and electromagnetic pulsing.

 

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.

 

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 and other publicly available documents may contain or incorporate 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 our industry, expressed or implied in such forward-looking statements. Such factors include, among others, general industry, economic and business 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. 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.”

 

Capital Structure Risk

 

The aircraft leasing business is capital intensive and we have a substantial amount of indebtedness, which requires significant interest and principal payments. As of December 31, 2010, we had approximately $27.6 billion in principal amount of indebtedness outstanding.

Our substantial level of indebtedness could have important consequences to holders of our debt, including the following:

 

 

Liquidity Risk

 

We will require a significant amount of cash to service our indebtedness and make planned capital expenditures and we may not have adequate capital resources to meet our obligations as they become due. 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 included both public debt and bank facilities.

 

In 2009, we had limited access to our traditional sources of liquidity and we borrowed $3.9 billion from AIG Funding to fulfill our liquidity needs. In 2010, we regained access to debt markets, to which we had limited access throughout 2009. During the year ended December 31, 2010, we borrowed approximately $9.8 billion through secured and unsecured financings, which generated proceeds, net of discounts, aggregating $9.7 billion, to support our liquidity needs in excess of our operating cash flows. We used part of the proceeds received from these debt issuances to prepay in full the principal balance of $3.9 billion, plus accrued interest, of our loans from AIG Funding, originally due in 2013. In the fourth quarter of 2010, we also repaid in full and terminated our $2.0 billion revolving credit facility dated October 14, 2005 and repaid $800 million aggregate principal amount of loans outstanding under our $2.5 billion credit facility dated October 13, 2006. On January 31, 2011, we entered into a new three-year $2.0 billion unsecured revolving credit facility.

 

Any new issuance of debt by us or our subsidiaries will be subject to the consent of the Department of the Treasury if, after giving effect to the incurrence of the debt and use of proceeds therefrom, we increase our net indebtedness by more than $1 billion compared to the same date in the previous year, or compared to December 8, 2010, if the measurement is made before December 8, 2011. We cannot predict whether the Department of the Treasury would consent to us incurring debt in excess of this amount.

 

Our bank credit facilities and indentures also limit our ability to incur secured indebtedness. The most restrictive covenant in our bank credit facilities permits us and our subsidiaries to incur secured indebtedness totaling up to 30% of our consolidated net tangible assets, as defined in the credit agreement, minus $2.0 billion, which limit currently totals approximately $10.0 billion. As of March 4, 2011, we were able to incur an additional $4.8 billion of secured indebtedness under this covenant. Our debt indentures also restrict us and our subsidiaries from incurring secured indebtedness in excess of 12.5% of our consolidated net tangible assets, as defined in the indentures. However, we may obtain secured financing without regard to the 12.5% consolidated net tangible asset limit under our indentures by doing so through subsidiaries that qualify as non-restricted under our debt indentures.

 

In addition to addressing our liquidity needs through debt financings, we also pursue potential aircraft sales in connection with our ongoing fleet strategy. During the year ended December 31, 2010, we sold 59 aircraft for approximately $2.0 billion in gross proceeds. Since December 31, 2010, we have sold an additional four aircraft for additional proceeds of $127.1 million. In evaluating potential sales, we balance 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 of any such portfolio, and whether we could reach an agreement with terms acceptable to all parties. Furthermore, we would need approval from the Department of the Treasury if

we entered into sales transactions with aggregate consideration exceeding $2.5 billion during any twelve-month period. Therefore, we cannot predict whether any additional sales of aircraft will occur.

 

Because the current market for aircraft is depressed due to the economic downturn and limited availability of buyer financing, sales of aircraft 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.

 

We may, or may not, continue to have access to the secured or unsecured debt markets in the future or be able to sell additional aircraft. We believe that our cash on hand, including cash generated from the above-mentioned financing arrangements, and cash flows generated from operations, which include aircraft sales, are sufficient for us to operate our business and repay our maturing debt obligations for the next twelve months. If we are unable to generate or raise sufficient cash, 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 financing, credit ratings also directly affect 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. Our credit rating downgrades, combined with externally generated volatility, limited our ability to access debt markets and resulted in higher funding costs. Although we began to regain access to the debt markets in 2010, further ratings downgrades could increase our borrowing costs and limit our access to the debt markets.

 

Additionally, our current long-term debt ratings impose the following restrictions under our 2004 ECA facility: (i) we must segregate all security deposits, overhaul rentals and rental payments related to the aircraft financed under our 2004 ECA facility into separate accounts controlled by the security trustee (segregated rental payments are used to make scheduled principal and interest payments on the outstanding debt) and (ii) we must file individual mortgages on the aircraft funded under the 2004 ECA facility in the local jurisdictions in which the respective aircraft are registered. At December 31, 2010, the same restrictions applied to our 1999 ECA facility, but subsequent to December 31, 2010, we repaid in full all of the loans that were outstanding under the 1999 ECA facility. At March 4, 2011, there are no amounts outstanding under the 1999 ECA facility. At December 31, 2010, we had segregated security deposits, overhaul rentals and rental payments aggregating approximately $393.7 million related to aircraft funded under the 1999 and 2004 ECA facilities, of which $12.5 million was returned to us subsequent to December 31, 2010, after we repaid in full all of the loans that were outstanding under the 1999 ECA facility.

 

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 varying debt maturities.

 

Our cost of borrowing for new financings has increased due to our long-term debt ratings. 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. In the fourth quarter of 2010, using available cash on hand, we (i)  repaid in full $2.0 billion in principal amount outstanding plus accrued interest under our $2.0 billion credit agreement dated October 14, 2005, and (ii)  repaid $800 million aggregate principal amount of loans outstanding under our $2.5 billion credit agreement dated October 13, 2006, in connection with other amendments to that credit agreement. These obligations had interest rates of 0.91% and 3.25%, respectively, at the time of their respective repayment. Subsequent to repayment of these obligations, as well as repayments of other scheduled maturities, our composite interest rate increased from 5.17% at September 30, 2010, to 5.66% at December 31, 2010. We expect our composite interest rate to increase further as our lower cost financings mature. A 1% increase in our composite

interest rate at December 31, 2010, would have increased our interest expense by approximately $280 million annually, which would put downward pressure on our operating margins.

 

Restrictive Covenants on Our Operations

 

The agreements governing certain of our indebtedness contain covenants that restrict, among other things, our ability to:

 

 

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

 

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; and we can give no assurance how further changes in circumstances related to AIG may impact us.

 

AIG Master Transaction Agreement with the Department of the Treasury — Although we are not a party to the Master Transaction Agreement that AIG entered into on December 8, 2010, with the Department of the Treasury (the “Master Transaction Agreement”), we are a Designated Entity under the agreement, and we and our subsidiaries are restricted from taking certain significant actions without obtaining prior written consent from the Department of the Treasury under the agreement, including:

 

 

Additionally, under the Master Transaction Agreement, if AIG has not repaid certain loans to the Department of Treasury by May 1, 2013, the Department of the Treasury may direct AIG to sell certain assets, including shares of ILFC.

 

AIG as Our Counterparty of Derivatives — 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.

 

Key Personnel Risk

 

Our senior management’s reputation and relationships with lessees and sellers of aircraft are an important element of our business. The American Recovery and Reinvestment Act of 2009 (the “Act”) imposed restrictions on bonus and other incentive compensation payable to certain AIG employees. Our President and Vice Chairman has been subject to the compensation limitations imposed by the Act since 2009 and three other members of our senior management team will become subject to the limitations in 2011. The restrictions and limitations on compensation imposed on us may adversely affect our ability to attract new talent and retain and motivate our existing impacted employees. If we are unable to retain our key employees due to the compensation restrictions or for any other reason, and we fail to attract new talent, it 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 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, that meet the airlines’ demands, in both type and quantity, and fulfilling their contractual obligations to us. Should the manufacturers fail to respond appropriately to changes in the market environment or fail to fulfill their contractual obligations, we may experience:

 

 

For example, we have ordered 74 787 aircraft 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 with customers for 37 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 December 31, 2010, there have been no cancellations by any party related to the delays. We are in discussions with Boeing related to revisions to the delivery schedule and potential delay compensation for which we may be eligible.

 

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. During the twelve months ended December 31, 2010, we took impairment charges aggregating approximately $948.7 million related to our fleet held for use and additional impairment charges and fair value adjustments aggregating $550.0 million related to aircraft we sold, held for sale, had agreed to sell or designated for part-out. See Notes D of Notes to Consolidated Financial Statements. 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.

 

In 2010 we recorded impairment charges on certain aircraft types due to unfavorable trends affecting the airline industry in general and specific models of aircraft, including the potential for lower demand for certain aircraft models as a result of the announcement from Airbus of new, efficient engine options for its future narrow body aircraft. See Note D of Notes to Consolidated Financial Statements.

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 — In August 2010 the Financial Accounting Standards Board (“FASB”) issued an Exposure Draft that proposes substantial changes to existing lease accounting that will affect all lease arrangements. The FASB’s proposal requires that all leases be recorded on the statement of financial position of both lessees and lessors.

 

Under the proposed accounting model, lessees will be required to record an asset representing the right-to-use the leased item for the lease term (“Right-of-Use Asset”) and a liability to make lease payments. The Right-of-Use asset and liability incorporate the rights, including renewal options, and obligations, including contingent payments and termination payments, arising under the lease and are based on the lessee’s assessment of expected payments to be made over the lease term. The proposed model requires measuring these amounts at the present value of the future expected payments.

 

Under the proposed accounting model, lessors will apply one of two approaches to each lease based on whether the lessor retains exposure to significant risks or benefits associated with the underlying asset, as defined. The performance obligation approach will be applied when the lessor has retained exposure to significant risks or benefits associated with the underlying lease, and the de-recognition approach will apply when the lessor does not retain significant risks or benefits associated with the underlying asset.

 

The comment period for this proposal ended in December 2010 and the FASB intends to issue a final standard in 2011. The proposal does not include a proposed effective date; rather it is expected to be considered as part of the evaluation of the effective dates for the major projects currently undertaken by the FASB. The FASB continues to deliberate on the proposed accounting as presented in the Exposure Draft. In subsequent meetings in January and February 2011, the FASB discussed and agreed to make substantial revisions to the proposed accounting in the Exposure Draft. These affect both lessees and lessors. As a result, currently management is unable to assess the effects the adoption of the new finalized lease standard will have on our financial statements. Although we believe the presentation of our financial statements, and those of our lessees, could change, we do not believe the accounting pronouncement will change the fundamental economic reasons for which the airlines lease aircraft. Therefore, we do not believe it will have a material impact on our business.

 

Tax Related Risk — We operate in multiple jurisdictions and may become subject to a wide range of income and other taxes. If we are unable to execute our business in jurisdictions with preferential tax treatment, we may be subject to significant income and other taxes on operations.

 

 

None

 

 

Flight Equipment

 

Management frequently reviews 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.

 

At December 31, 2010, the average age of aircraft in our fleet was 8.5 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, 2010:

 

 

As of March 4, 2011, leases covering 21 of the 49 aircraft with lease expiration dates in 2011 had been extended or leased to other customers, and one aircraft is more likely than not to be sold during 2011.

 

Commitments

 

At December 31, 2010, we had committed to purchase the following new aircraft at an estimated aggregate purchase price (including adjustment for anticipated inflation) of approximately $13.5 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, 2010, we had made non-refundable deposits (exclusive of capitalized interest) with respect to the aircraft which we have committed to purchase of approximately $118.6 million with Boeing and $23.1 million with Airbus. In the first quarter of 2011, we signed a memorandum of understanding to purchase 75 A320neos and 25 A321neos from Airbus, which will replace our previous A380 commitments, and a purchase agreement for 33 737-800 aircraft from Boeing. The estimated aggregate purchase price for the 133 aircraft is approximately $7.5 billion and the aircraft will deliver through 2019.

 

As of March 4, 2011, 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, 2010, 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, Yemen Airways-Yemenia and Airblue Limited:  We are named in lawsuits in connection with the 2004 crash of our Boeing 737-300 aircraft on lease to Flash Airlines, an Egyptian carrier; the 2009 crash of our Airbus A310-300 aircraft on lease to Yemen Airways-Yemenia, a Yemeni carrier; and the 2010 crash of our Airbus A320-200 aircraft on lease to Airblue Limited, a Pakistani carrier. These lawsuits were filed by the families of victims on the flights and seek unspecified damages for wrongful death, costs, and fees. The Flash Airlines litigation originally commenced in May 2004 in California, but all U.S. proceedings were dismissed in favor of proceedings in France where claims are pending before the Tribunal de Grande Instance civil courts in Bobigny and Paris. As of March 4, 2011, the parties are engaged in settlement negotiations. We believe that we have substantial defenses to this action and available liability insurance is adequate to cover our defense costs and any potential liability. The Yemen Airways litigation was filed in January 2011 in California Superior Court in Los Angeles County. We have been served with the complaint and the litigation is in its incipient stages. While plaintiffs have not specified any amount of damages, we believe that we are adequately covered by available liability insurance and that we have substantial defenses to this action. The Airblue Limited litigation commenced in Cook County, Illinois in September 2010. The case was removed to the U.S. district court for the Northern District of Illinois and plaintiffs voluntarily dismissed their claims without prejudice. We do not believe that the outcome of any of these lawsuits will have a material effect on our consolidated financial condition, results of operations or cash flows.

Estate of Volare Airlines:  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 by an entity that is a related party to us of one A330-200 aircraft. In October 2009, the Volare bankruptcy receiver filed a claim in an Italian court in the amount of €29.6 million against us and our related party for the return to the Volare estate of all payments made by it to us and our related party in the year prior to Volare’s bankruptcy filing. We are currently engaged in settlement negotiations and at December 31, 2010, we had accrued the proposed settlement amount in our consolidated financial statements. We do not expect any settlement payment to be material to our consolidated financial position, results of operations or cash flows.

 

Krasnoyarsk Airlines:  We leased a 757-200ER aircraft to a Russian airline, KrasAir, which became the subject of a Russian bankruptcy-like proceeding. The aircraft was detained by the Russian customs authorities on the basis of certain alleged violations of the Russian customs code by KrasAir. While we prevailed in court proceedings, Russian custom authorities would not provide relevant documents to permit the aircraft to be removed from Russia. Therefore, we took possession of the engines only, and recorded impairment charges in the amount of $20.8 million for the year ended December 31, 2010, to reduce the value of the aircraft to the fair value of the engines. We do not intend to pursue the return of this aircraft further.

 

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 2010 or 2009. Under the most restrictive provision of our debt agreements, we may declare and pay dividends of up to $1.9 billion of our consolidated retained earnings. Under certain of our debt agreements, we are currently restricted from using proceeds from asset sales to pay dividends to AIG but may use other funds to pay such dividends.

 

 

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.

 

 

 

 

 

 

 

 

Overview

 

ILFC’s primary business operation is to acquire new commercial jet aircraft from aircraft manufacturers and other parties and lease those aircraft to airlines throughout the world.

 

We generate the majority of our revenues from leasing new and used commercial jet aircraft to foreign and domestic airlines. We also generate revenues from: (i) remarketing commercial jet aircraft for our own account when we sell our leased aircraft at or before the expiration of their leases; (ii) providing fleet management services to leasing, re-leasing and sales services on behalf of the owner of aircraft; and (iii) fees received in exchange for providing asset value guarantees on aircraft and, in limited circumstances, loan guarantees to buyers of aircraft or to financial institutions.

 

Starting in the third quarter of 2008, worldwide economic conditions began to deteriorate significantly. The decline in economic conditions resulted in highly volatile markets, a steep decline in equity markets, less liquidity, the widening of credit spreads and several prominent financial institutions seeking governmental aid. As a result of the general economic conditions and circumstances specific to AIG, our long-term debt ratings dropped and we became unable to access the debt capital markets and relied primarily on loans from AIG Funding. In 2010, we saw significant improvements in these conditions and regained access to the debt markets, as further discussed under “Debt Financings” below.

 

In 2011, we intend to focus on the following items, with the primary objective of improving our credit rating:

 

 

Operating Results

 

We reported a net loss of approximately $383.8 million for the year ended December 31, 2010, compared to net income of approximately $895.6 million for the year ended December 31, 2009. The loss reported for the year ended December 31, 2010 was primarily due to the following: (i)  impairment charges and fair value adjustments and other lease related charges on aircraft we sold or agreed to sell during 2010 to generate liquidity to repay maturing debt obligations or as part of our ongoing fleet strategy; (ii) impairment charges related to our fleet held for use; and (iii) an increase in our cost of borrowing.

 

Impairment charges and fair value adjustments of aircraft sold, agreed to be sold, held for sale or designated for part-out:  Due to unfavorable market conditions in 2010, we recorded impairment charges and fair value adjustments aggregating approximately $550.0 million and lease related charges aggregating approximately $91.2 million related to aircraft agreed to be sold, held for sale or designated for part-out for the year ended December 31, 2010. We recorded impairment charges and fair value adjustments for the following events in 2010: (i) we reclassified 60 aircraft that we intended to sell, primarily to generate liquidity, from Flight equipment under operating leases into Flight equipment held for sale and completed the sale of 51 of those aircraft during 2010; (ii) we identified another 15 aircraft as likely to be sold as part of our ongoing fleet strategy, and completed the sale of eight of those aircraft during 2010, two of which were accounted for as sales-type leases; and (iii) we designated two aircraft for part-out.

 

At December 31, 2010, we had nine aircraft classified as Flight equipment held for sale and expect to complete most of the sales during the first quarter of 2011. As of March 4, 2011, we had completed the sale of four of the remaining nine aircraft. The 60 aircraft transferred from our fleet held for use to Flight equipment held for sale during the year ended December 31, 2010, generated aggregate quarterly lease revenue of approximately $75 million and the quarterly depreciation aggregated approximately $27 million.

Impairment of our fleet held for use:  For the year ended December 31, 2010, we recorded impairment charges aggregating approximately $948.7 million related to 78 aircraft, as part of our ongoing recoverability assessments. The impairment charges primarily resulted from changes in management’s outlook related to the future recovery of the airline industry due to a decrease in future estimated demand for certain aircraft types, expected increased volatility in fuel costs and changes in other macroeconomic conditions, which, when aggregated, resulted in lower future estimated lease rates. See Our Fleet and Aircraft Industry and Sources of Revenue below for a more detailed discussion.

 

During the years ended December 31, 2010 and 2009, we recorded the following impairment charges and fair value adjustments. We did not record any impairment charges or fair value adjustments for the year ended December 31, 2008.

 

 

Cost of borrowing:  Our cost of borrowing is increasing as we pay down or refinance our existing debt with new financing arrangements, reflecting higher interest rates caused by our lower long-term debt ratings. Our average composite interest rate for the year ended December 31, 2010, increased by 0.6% as compared to the year ended December 31, 2009. Our average debt outstanding decreased by approximately $2.4 billion for the year ended December 31, 2010, as compared to the year ended December 31, 2009. We expect our future composite interest rate to increase further as our lower cost financings mature.

 

Our Fleet

 

As of December 31, 2010, we owned 933 aircraft, had four additional aircraft in the fleet classified as finance and sales-type leases, and provided fleet management services for 97 aircraft. We have contracted with Airbus and Boeing to buy 115 new aircraft for delivery through 2019 with an estimated purchase price of $13.5 billion, six of which are scheduled to deliver during 2011. We did not enter into any new purchase agreements with manufacturers during 2010.

 

In the first quarter of 2011, we signed a memorandum of understanding to purchase 75 A320neos and 25 A321neos from Airbus, which will replace our previous A380 commitments, and a purchase agreement for 33 737-800 aircraft from Boeing. The estimated aggregate purchase price for the 133 aircraft is approximately $7.5 billion and the aircraft will deliver through 2019.

During the year ended December 31, 2010, we had the following activity related to Flight equipment under operating leases:

 

 

 

 (a) Includes two aircraft that were converted to sales-type leases.

 

 (b) As of December 30, 2010, 51 of these aircraft were sold to third parties.

 

During 2010, four of our lessees filed for bankruptcy protection or ceased operations: (i)  Skyservice Airlines Inc., operating one of our owned aircraft, ceased operations on March 31, 2010; (ii)  Mexicana de Aviación, operating 12 of our owned aircraft, of which eight were leased from us and four were subleased from another one of our customers, filed for bankruptcy protection on August 2, 2010; (iii) Viking Airlines AB, operating one of our owned aircraft, ceased operations on October 15, 2010; and (iv) Eurocypria Airlines Limited, operating five of our owned aircraft, ceased operations on November 4, 2010. As of March 4, 2011, we had sold one of these aircraft and all the remaining aircraft previously leased directly from us had been leased to other airlines, while the four aircraft that were subleased remained on lease with the sublessor airline. All aircraft in our fleet were subject to lease agreements or letters of intent at December 31, 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, which 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 aircraft that are less in demand and have lower lease rates. As of December 31, 2010, we identified 63 aircraft that were most susceptible to failing the recoverability assessment. Of the 63 aircraft identified, two aircraft did not pass the full undiscounted recoverability assessment and a corresponding impairment was recognized for the year ended December 31, 2010. The remaining 61 aircraft passed the recoverability assessment with undiscounted cash flows exceeding the carrying value of aircraft from 0.2% to 197% which represents a 22% aggregate excess above the aggregate net carrying value of those aircraft. These 61 aircraft had an aggregate net carrying value of approximately $3.4 billion at December 31, 2010. Management believes that the carrying values at December 31, 2010, of these, as well as all our other aircraft, are supported by the estimated future undiscounted cash flows expected to be generated by each aircraft.

 

As of December 31, 2010, ILFC had 13 passenger configured 747-400’s and 11 A321-100’s in its fleet. Management’s estimate of the future lease rates for these aircraft types declined significantly in the third quarter of 2010. The decline in expected lease rates for the 747-400’s was due to a number of unfavorable trends, including lower overall demand, as airlines replace their 747-400’s with more efficient newer generation wide-body aircraft. As a result, the current global supply of 747-400 aircraft that are for sale, or idle, has increased. It is expected that these unfavorable trends will persist. The decline in A321-100 lease rates is primarily due to continued and accelerated decrease in demand for this aircraft type, which is attributable to its age and limited mission application. As a result of the decline in expected future lease rates, seven 747-400’s, five A321-100’s, and five other aircraft, including the two discussed above, in our fleet held for use were deemed impaired when we performed our recoverability assessments of the entire fleet we held for use during 2010. As a result, we recorded impairment

charges aggregating $391.3 million to write these aircraft down to their respective fair values. The estimated undiscounted cash flows on the remaining six 747-400’s and six A321-100’s support the current carrying value of these aircraft. See Note D of Notes to Consolidated Financial Statements.

 

On December 1, 2010, Airbus announced new fuel efficient engine options for its narrow body neo aircraft with expected deliveries starting in 2016. At December 31, 2010, we had identified 78 narrow body aircraft with first generation engines in our fleet that may be negatively impacted by the introduction of the neo and, as part of our on-going fleet assessment, we performed a recoverability analysis on those aircraft, using revised cash flow assumptions. Based on this recoverability analysis, 61 of these 78 aircraft were deemed impaired and we recorded impairment charges of approximately $557.4 million for the three months ended December 31, 2010.

 

For the year ended December 31, 2010, as discussed in detail above, we recorded aggregate impairment charges of approximately $948.7 million related to 78 aircraft in our fleet held for use. The impairment charges reflect management’s outlook related to the future recovery of the airline industry, a decrease in demand for certain aircraft types, expected increased volatility in fuel costs and changes in other macroeconomic factors which, when aggregated, resulted in lower future estimated lease rates on certain aircraft. We also recorded impairment charges and fair value adjustments aggregating $550.0 million related to aircraft sold, likely to be sold or reclassified as Flight equipment held for sale for the year ended December 31, 2010, as discussed above under Operating Results.

 

There are lags between changes in market conditions and their impact on our results, as contracts not yet reflecting current lease rates remain in effect. Therefore, the current market conditions and any potential effect they may have on our results may not yet be fully reflected in our current results. Management monitors all lessees that are behind in lease payments and discusses relevant operational and financial issues faced by 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. At December 31, 2010, eight customers operating 22 aircraft were two or more months past due on $11.1 million of lease payments related to some of those aircraft. Of this amount, we recognized $10.1 million in rental income through December 31, 2010, and as of March 4, 2011, we had collected $6.0 million thereof. In comparison, at December 31, 2009, 12 customers operating 25 aircraft were two or more months past due on $31.9 million of lease payments relating to some of those aircraft.

 

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 with our marketing executives relevant operational and financial issues faced by the lessees. As of December 31, 2010, customers with $1.3 million carrying value of notes receivable were two months or more behind on principal and interest payments totaling $0.7 million.

 

Aircraft Industry and Sources of Revenue

 

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, natural disasters, 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.

 

In each of April and May 2010, European air space was closed to air traffic for a number of days as a result of eruptions of an Icelandic volcano. The International Air Transport Association has estimated lost revenue for the airline industry in excess of $1.7 billion during these periods. The eruptions had no significant impact on our operating income for the year ended December 31, 2010.

 

The Middle East and Northern Africa have recently experienced political unrest due to antigovernment protests. We have 71 aircraft on lease in the region. The airlines in the region continue to operate these 71 aircraft and the unrest has had no significant impact on our operating results to date.

 

In the second half of 2010, there were notable improvements in passenger and freight traffic resulting in an increase in demand for aircraft subject to operating leases. This resulted in higher lease rates for ILFC’s most in-

demand aircraft. Currently, our customers are increasingly willing to extend their existing leases. We believe that the worst of this cyclical downturn has passed and that our business, and that of our customers, will continue to improve during 2011. Nevertheless, we believe growth will remain vulnerable to increasing fuel costs and other political and economic disruptions.

 

Despite industry cyclicality and current financial stress, we are optimistic about the long-term future of air transportation and, more specifically, the growing role that the leasing industry, and ILFC specifically, provides in the fleet transactions necessary to facilitate the growth of commercial air transport. We believe that airlines will continue to value the fleet flexibility offered by leasing aircraft. We also expect lease rates for certain aircraft to begin to stabilize and improve, which we believe could result in some recovery in market values of aircraft. At March 4, 2011, we have signed leases for all of our new aircraft deliveries on order at December 31, 2010 through the end of August 2012. Furthermore, in the first quarter of 2011, we signed a memorandum of understanding to purchase 75 A320neos and 25 A321neos from Airbus, which will replace our previous A380 commitments, and a purchase agreement for 33 737-800 aircraft from Boeing. The estimated aggregate purchase price for the 133 aircraft is approximately $7.5 billion and the aircraft will deliver through 2019. For these reasons, we believe we are well positioned to manage the current cycle and to take advantage of improving market conditions.

 

Liquidity

 

During 2010, we regained access to debt markets, to which we had limited access throughout 2009. During the year ended December 31, 2010, we borrowed approximately $9.8 billion through secured and unsecured financings, which generated proceeds, net of discounts, aggregating $9.7 billion, to support our liquidity needs in excess of our operating cash flows. We used part of the proceeds received from these debt issuances to prepay in full the principal balance of $3.9 billion, plus accrued interest, of our loans from AIG Funding, originally due in 2013. In the fourth quarter of 2010, we also repaid in full and terminated our $2.0 billion revolving credit facility dated October 14, 2005 and repaid $800 million aggregate principal amount of loans outstanding under our $2.5 billion credit facility dated October 13, 2006. On January 31, 2011, we entered into a new three-year $2.0 billion unsecured revolving credit facility. At December 31, 2010, we had approximately $3.1 billion of unrestricted cash and cash equivalents.

 

Any new issuance of debt by us or our subsidiaries will be subject to the consent of the Department of the Treasury if, after giving effect to the incurrence of the debt and use of proceeds therefrom, we increase our net indebtedness by more than $1 billion compared to the same date in the previous year, or compared to December 8, 2010, if the measurement is made before December 8, 2011. We cannot predict whether the Department of the Treasury would consent to us incurring debt in excess of this amount.

 

Our bank credit facilities and indentures also limit our ability to incur secured indebtedness. The most restrictive covenant in our bank credit facilities permits us and our subsidiaries to incur secured indebtedness totaling up to 30% of our consolidated net tangible assets, as defined in the credit agreement, minus $2.0 billion, which limit currently totals approximately $10.0 billion. As of March 4, 2011, we were able to incur an additional $4.8 billion of secured indebtedness under this covenant. Our debt indentures also restrict us and our subsidiaries from incurring secured indebtedness in excess of to 12.5% of our consolidated net tangible assets, as defined in the indentures. However, we may obtain secured financing without regard to the 12.5% consolidated net tangible asset limit under our indentures by doing so through subsidiaries that qualify as non-restricted under our debt indentures.

 

In addition to addressing our liquidity needs through debt financings, we also pursue potential aircraft sales in connection with our ongoing fleet strategy. During the year ended December 31, 2010, we sold 59 aircraft for approximately $2.0 billion in gross proceeds. Since December 31, 2010, we have sold an additional four aircraft for additional proceeds of $127.1 million. In evaluating potential sales, we balance 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 of any such portfolio, and whether we could reach an agreement with terms acceptable to all parties. Furthermore, we would need approval from the Department of the Treasury if we entered into sales transactions with aggregate consideration exceeding $2.5 billion during any twelve-month period. Therefore, we cannot predict whether any additional sale of aircraft will occur.

 

Because the current market for aircraft is depressed due to the economic downturn and limited availability of buyer financing, any 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.

 

We believe the sources of liquidity mentioned above, together with our cash generated from operations, will be sufficient to operate our business and repay our debt maturities for at least the next twelve months.

 

Our Relationship with AIG

 

Potential Change in Ownership

 

AIG does not have any present intention to sell us. If AIG does sell more than 49% of our common stock without certain lenders’ consent, it would be an event of default under one of our credit agreements and would allow our lenders to declare such debt immediately due and payable. Accordingly, any such sale of us by AIG would require consideration of this credit agreement. As of the date of this report, we had approximately $1.7 billion outstanding under such credit agreement. In addition, an event of default or declaration of acceleration under such credit agreement could also result in an event of default under our other debt agreements, including the indentures governing our public debt.

 

AIG Loans from the FRBNY and Department of the Treasury

 

In September 2008, liquidity issues resulted in AIG seeking and receiving governmental support through the FRBNY Credit Facility and TARP funding from the Department of the Treasury, as more fully described in AIG’s Annual Report on Form 10-K for the year ended December 31, 2010. On January 14, 2011, AIG was recapitalized (“the Recapitalization”) and the FRBNY Credit Facility was repaid and terminated through a series of transactions, including the Master Transaction Agreement discussed below, that resulted in the Department of the Treasury becoming AIG’s majority shareholder with ownership of approximately 92% of AIG’s outstanding common stock. AIG understands that, subject to market conditions, the Department of the Treasury intends to dispose of its ownership interest in AIG over time.

 

Master Transaction Agreement

 

The Master Transaction Agreement entered into by AIG and the Department of the Treasury imposes several restrictions on us. In particular, we and our subsidiaries are restricted from taking certain significant actions without obtaining prior written consent from the Department of the Treasury. These significant actions include amending or waiving any provisions of our articles of incorporation, bylaws, or similar organizational document in a manner that would adversely affect, in any material respect, the rights of our equity interests; authorizing or issuing any equity interests, unless to AIG or a wholly owned subsidiary of AIG; selling or disposing of assets for total consideration greater than or equal to $2.5 billion in any twelve-month period; acquiring assets after December 8, 2010, other than pursuant to existing purchase commitments at such date, with aggregate scheduled payments under the purchase contracts for such assets greater than or equal to $2.5 billion in any twelve-month period; engaging in any public offering or other sale or transfer of our equity interests; voluntarily liquidating, filing for bankruptcy, or taking any other legal action evidencing insolvency; and increasing our net indebtedness by more than $1 billion compared to the same date in the previous year, or compared to December 8, 2010, if the measurement is made before December 8, 2011.

 

Additionally, under the Master Transaction Agreement, if AIG has not repaid certain loans to the Department of Treasury by May 1, 2013, the Department of the Treasury may direct AIG to sell certain assets, including shares of ILFC.

 

Debt Financings

 

We generally fund our operations, including aircraft purchases, through available cash balances, internally generated funds, including aircraft sales, 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 included both public debt and bank facilities. In 2009, we had limited access to our traditional sources of liquidity and we borrowed $3.9 billion from AIG Funding to fulfill our liquidity needs.

 

During the year ended December 31, 2010, we borrowed approximately $9.8 billion and $3.3 billion was provided by operating activities. The $9.8 billion included the following financings: (i) $326.8 million borrowed

under our 2004 ECA facility, which was used to finance five Airbus aircraft and to re-finance five Airbus aircraft purchased in 2009; (ii) new secured financing transactions aggregating $5.2 billion; (iii) $2.75 billion aggregate principal amount of unsecured senior notes issued in private placements; and (iv) $1.5 billion aggregate principal amount of unsecured senior notes issued under our shelf registration statement. As we pay down or refinance our existing lower cost debt with higher cost financings, our composite interest rate will increase.

 

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

 

 

 

 

The above amounts represent the anticipated settlement of our outstanding debt obligations as of December 31, 2010 and December 31, 2009. 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 U.S. 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 $165.4 million and $391.1 million at December 31, 2010 and 2009, respectively. Composite interest rates and percentages of total debt at fixed rates reflect the effect of derivative instruments. The higher composite interest rate at December 31, 2010, compared to December 31, 2009, is due to recently issued secured and unsecured debt with higher interest rates than our older debt due to our current long-term debt ratings and repayments of debt with relatively lower interest rates. We expect our composite interest rate to increase further as we pay down or refinance our existing lower cost debt.

After incurring impairment and fair value adjustment losses on certain aircraft, as discussed under Results of Operations, as of September 30, 2010, our fixed charge coverage ratio was close to the minimum ratio of 1.10x required under our credit agreement dated October 13, 2006. We entered into an amendment, effective December 22, 2010, to exclude such impairment and fair value adjustments from the calculation of our fixed charge coverage ratio. The fixed charge coverage ratio was previously defined within such credit agreement as the ratio of earnings for the period of four fiscal quarters ending on the last day of the reporting period to combined fixed charges and preferred stock dividends referred to in paragraph (d)(1) of Item 503 of Regulation S-K under the Securities Act of 1933, and determined pursuant to the Instructions to such Item 503(d). The amendment allows for the addition to earnings of impairment charges and fair value adjustments incurred during the period in connection with adjustments to fair value of aircraft owned at any time during the period, to the extent such impairment charges and fair value adjustments were deducted when arriving at earnings for the period. As a condition to the effectiveness of the amendment, we repaid $800 million aggregate principal amount of loans outstanding under such credit facility.

 

At December 31, 2010, 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, or financial leverage ratio, a minimum fixed charge coverage ratio and a minimum consolidated tangible net worth.

 

We have created wholly-owned subsidiaries for the purpose of purchasing aircraft and obtaining financings secured by such aircraft. These entities are non-restricted subsidiaries, as defined by our debt indentures, and meet the definition of a VIE. We have determined that we are the primary beneficiary of such VIEs and, accordingly, we consolidate such entities into our consolidated financial statements. See Note O of Notes to Consolidated Financial Statements for more information on VIEs.

 

The following table presents information regarding the collateral provided for our secured debt:

 

 

Senior Secured Notes

 

On August 20, 2010, we issued $3.9 billion of senior secured notes, with $1.350 billion maturing in September 2014 and bearing interest of 6.5%, $1.275 billion maturing in September 2016 and bearing interest of 6.75%, and $1.275 billion maturing in September 2018 and bearing interest of 7.125%. The aggregate net proceeds from the issuances were approximately $3.84 billion after deducting initial purchaser discounts and commissions, fees and offering expenses. The notes are secured by a designated pool of aircraft, initially consisting of 174 aircraft and their related leases and certain cash collateral. In addition, two of ILFC’s subsidiaries, that either own or hold leases of aircraft included in the pool securing the notes, have guaranteed the notes. We can redeem the notes at any time prior to their maturity, provided we give notification between 30 to 60 days prior to the intended redemption date and subject to a penalty of the greater of 1% of the outstanding principal amount and a “make-whole” premium. There is no sinking fund for the notes.

 

The indenture governing the senior secured notes contains customary covenants that, among other things, restrict our and our restricted subsidiaries’ ability to: (i) create liens; (ii)  sell, transfer or otherwise dispose of assets; (iii) declare or pay dividends or acquire or retire shares of our capital stock; (iv) designate restricted subsidiaries as non-restricted subsidiaries or designate non-restricted subsidiaries; (v) make investments in or transfer assets to non-restricted subsidiaries; and (vi) consolidate, merge, sell or otherwise dispose of all, or substantially all, of our assets.

The indenture also provides for customary events of default, including but not limited to, the failure to pay scheduled principal and interest payments on the notes, the failure to comply with covenants and agreements specified in the indenture, the acceleration of certain other indebtedness resulting from non-payment of that indebtedness, and certain events of insolvency. If any event of default occurs, any amount then outstanding under the senior secured notes may immediately become due and payable.

 

We used proceeds from the issuance of the senior secured bonds to repay in full our loans from AIG Funding, as discussed above.

 

ECA Financings

 

We entered into ECA facility agreements in 1999 and 2004 through non-restricted subsidiaries. The facilities were used to fund purchases of Airbus aircraft through 2001 and June 2010, respectively. New financings are no longer available to us under either ECA facility. The loans made under the ECA facilities were used to fund a portion of each aircraft’s net purchase price. The loans made under each ECA facility were guaranteed by various European ECAs. We have collateralized the debt under each ECA facility with pledges of the shares of wholly-owned subsidiaries that hold title to the aircraft financed under the facilities.

 

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%. At December 31, 2010, five loans with an aggregate principal value of $13.2 million remained outstanding under the facility and the net book value of the related aircraft was $1.6 billion. In January 2011, all of the amounts outstanding under the remaining five loans were repaid in full and no amounts remain outstanding under the 1999 ECA facility.

 

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. We used $4.3 billion of the available amount to finance purchases of 76 aircraft. Each aircraft purchased was financed by a ten-year fully amortizing loan. As of December 31, 2010, approximately $2.8 billion was outstanding under this facility. The interest rates on the loans outstanding under the facility are either fixed or based on LIBOR and ranged from 0.43% to 4.711% at December 31, 2010. The net book value of the related aircraft was $4.3 billion at December 31, 2010.

 

Our current long-term debt ratings require us to segregate security deposits, overhaul rentals and rental payments received for aircraft with loan balances outstanding under the 2004 ECA facility (segregated rental payments are used to make scheduled principal and interest payments on the outstanding debt). The segregated funds are deposited into separate accounts pledged to and controlled by the security trustee of the facility. In addition, we must register the existing individual mortgages on certain aircraft funded under both the 1999 and 2004 ECA facilities in the local jurisdictions in which the respective aircraft are registered (mortgages are only required to be filed on aircraft with loan balances outstanding or otherwise as agreed in connection with the cross-collateralization as described below). At December 31, 2010, we had segregated security deposits, overhaul rentals and rental payments aggregating approximately $393.7 million related to aircraft funded under the 1999 and 2004 ECA facilities, $12.5 million of which was returned to us subsequent to December 31, 2010, after we paid in full all amounts outstanding under the remaining five loans under the 1999 ECA facility. The segregated amounts will fluctuate with changes in security deposits, overhaul rentals, rental payments and debt maturities related to the aircraft funded under the 2004 ECA facility.

 

During the first quarter of 2010, we entered into agreements to cross-collateralize the 1999 ECA facility with the 2004 ECA facility. As part of such cross-collateralization we (i) guaranteed the obligations under the 2004 ECA facility through our subsidiary established to finance Airbus aircraft under our 1999 ECA facility; (ii) agreed to grant mortgages over certain aircraft financed under the 1999 ECA facility (including aircraft which are not currently subject to a loan under the 1999 ECA facility) and security interests over other collateral related to the aircraft financed under the 1999 ECA facility to secure the guaranty obligation; (iii) accepted a loan-to-value ratio (aggregating the loans and aircraft from the 1999 ECA facility and the 2004 ECA facility) of no more than 50%, in order to release liens (including the cross-collateralization arrangement) on any aircraft financed under the 1999 or 2004 ECA facilities or other assets related to the aircraft; and (iv) agreed to allow proceeds generated from certain disposals of aircraft to be applied to obligations under both the 1999 ECA and 2004 ECA facilities.

We also agreed to additional restrictive covenants relating to the 2004 ECA facility, restricting us from (i) paying dividends on our capital stock with the proceeds of asset sales and (ii) selling or transferring aircraft with an aggregate net book value exceeding a certain disposition amount, which is currently approximately $10.5 billion. The disposition amount will be reduced by approximately $91.4 million at the end of each calendar quarter during the effective period. The covenants are in effect from the date of the agreement until December 31, 2012. A breach of these restrictive covenants would result in a termination event for the ten loans funded subsequent to the date of the agreement and would make those loans, which aggregated $301.6 million at December 31, 2010, due in full at the time of such a termination event.

 

In addition, if a termination event resulting in an acceleration event were to occur under the 2004 ECA facility, we would have to segregate lease payments, overhaul rentals and security deposits received after such acceleration event occurred relating to all the aircraft funded under the 1999 ECA facility, including the aircraft no longer subject to a loan.

 

Secured Bank Debt

 

We have a credit facility, dated October 13, 2006, as amended, under which the original maximum amount available was $2.5 billion. On April 16, 2010, we entered into an amendment to this facility with lenders holding $2.155 billion of the then $2.5 billion of outstanding loans under the facility (the “Electing Lenders”). The Electing Lenders agreed to, among other things:

 

 

We entered into a second amendment, effective December 22, 2010, to this credit agreement that amended the definition of the fixed charge coverage ratio, a restrictive covenant under the agreement, to add to earnings any impairment charges and fair value adjustments incurred during the period, to the extent such impairment charges and fair value adjustments were deducted in computing earnings for the period. In conjunction with the amendment, we repaid $689.6 million of the secured loans and, as of December 31, 2010, we had secured loans of $1.465 billion outstanding under the facility, all of which will mature in October 2012.

 

We also repaid $110.4 million of the remaining $345 million of unsecured loans held by lenders who are not party to the amendment. The remaining $234.6 million outstanding at December 31, 2010, will mature on their originally scheduled maturity date in October 2011, with no increase to the interest rate margin.

 

The collateralization requirement under the amended facility provides that the loans held by Electing Lenders must be secured by a lien on the equity interests of certain of ILFC’s non-restricted subsidiaries that will own aircraft with aggregate appraised values of not less than 133% of the outstanding principal amount (the “Required Collateral Amount”). We must transfer all aircraft meeting the Required Collateral Amount to the pledged subsidiaries prior to April 16, 2011, subject to our right to post cash collateral for any shortfall. As of December 31, 2010, we had completed the transfers of all aircraft in an amount sufficient to meet the Required Collateral Amount. The credit facility also includes an ongoing requirement, tested periodically, that the appraised value of the eligible aircraft owned by the pledged subsidiaries must be equal to or greater than 100% of the Required Collateral Amount. This ongoing requirement is subject to the right to transfer additional eligible aircraft to the pledged subsidiaries or ratably prepay the loans held by the Electing Lenders. We also guarantee the loans held by the Electing Lenders through certain other subsidiaries.

 

The amended facility prohibits us from re-borrowing amounts repaid under this facility for any reason. Therefore, the current size of the facility is the $1.7 billion outstanding under the facility at December 31, 2010. The credit facility also contains financial and restrictive covenants that (i) limit our ability to incur indebtedness, (ii) restrict certain payments, liens and sales of assets by us, and (iii) require us to maintain a fixed charge coverage ratio and consolidated tangible net worth in excess of certain minimum levels.

Other Secured Financings

 

In May 2009, ILFC provided $39.0 million of subordinated financing to a non-restricted subsidiary. The entity used these funds and an additional $106.0 million borrowed from third parties to purchase an aircraft, which it 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 mature in May 2018 with interest rates based on LIBOR. At December 31, 2010, the interest rates on the $82.0 million and $24.0 million tranches were 3.408% and 5.108%, 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, 2010, $89.5 million was outstanding under the two tranches and the net book value of the aircraft was $137.1 million.

 

In June 2009, we borrowed $55.4 million through a non-restricted subsidiary, which owns one aircraft leased to an airline. Half of the original loan amortizes over five years and the remaining $27.7 million is due in 2014. The loan is non-recourse to ILFC and is secured by the aircraft and the lease receivables. The interest rate on the loan is fixed at 6.58%. At December 31, 2010, $46.7 million was outstanding and the net book value of the aircraft was $91.2 million.

 

On March 17, 2010, we entered into a $750 million term loan agreement secured by 43 aircraft and all related equipment and leases. The aircraft had an average appraised base market value of approximately $1.3 billion, for an initial loan-to-value ratio of approximately 56%. The loan matures on March 17, 2015, and bears interest at LIBOR plus a margin of 4.75% with a LIBOR floor of 2.0%. The principal of the loan is payable in full at maturity with no scheduled amortization, but we can voluntarily prepay the loan at any time, subject to a 1% prepayment penalty prior to March 17, 2011. On March 17, 2010, we also entered into an additional term loan agreement of $550 million through a newly formed non-restricted subsidiary. The obligations of the subsidiary borrower are guaranteed on an unsecured basis by ILFC and on a secured basis by certain non-restricted subsidiaries of ILFC that hold title to 37 aircraft. The aircraft had an average appraised base market value of approximately $969 million, for an initial loan-to-value ratio of approximately 57%. The loan matures on March 17, 2016, and bears interest at LIBOR plus a margin of 5.0% with a LIBOR floor of 2.0%. The principal of the loan is payable in full at maturity with no scheduled amortization. The proceeds from this loan are restricted from use in our operations until we transfer the related collateral to the non-restricted subsidiaries. At December 31, 2010, $63.3 million of the proceeds remained restricted. At March 4, 2011, approximately $17 million of the $63.3 million had become available to us. We can voluntarily prepay the loan at any time subject to a 2% prepayment penalty prior to March 17, 2011, and a 1% prepayment penalty prior to March 17, 2012. Both loans require a loan-to-value ratio of no more than 63%.

 

Loans from AIG Funding

 

We borrowed a total of $3.9 billion from AIG Funding from March 2009 to December 2009. These loans were scheduled to mature on September 13, 2013. The funds for the loans were provided to AIG Funding by the Federal Reserve Bank of New York (“FRBNY”) pursuant to the FRBNY Credit Facility. 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 Facility up to an amount equal to the aggregate outstanding balance of the loans from AIG Funding.

 

On August 20, 2010, we repaid all amounts outstanding under the loans from AIG Funding with the net proceeds from the issuance of $3.9 billion aggregate principal amount of senior secured notes and $500 million aggregate principal amount of senior notes. See “Senior Secured Notes” and “Unsecured Bonds and Medium-Term Notes.” As a result of our repayment of the loans from AIG Funding, the FRBNY released their liens on the collateral securing these loans.

 

Unsecured Bonds and Medium-Term Notes

 

Automatic Shelf Registration:  We have an automatic shelf registration statement filed with the SEC. As a result of our Well-Known Seasoned Issuer, or WKSI, status, we have an unlimited amount of debt securities registered for sale.

Pursuant to our automatic shelf registration: (i) on August 20, 2010, we issued $500 million of 8.875% notes due 2017 and (ii) on December 7, 2010, we issued $1.0 billion of 8.25% notes due 2020. At December 31, 2010, we also had $10.0 billion of public bonds and medium-term notes outstanding, with interest rates ranging from 0.61% to 7.95%, which we had issued in prior periods under previous registration statements.

 

Euro Medium-Term Note Programme:  We have a $7.0 billion Euro Medium-Term Note Programme under which we had approximately $1.2 billion and $1.9 billion of Euro denominated notes outstanding at December 31, 2010 and 2009 (€1.0 billion in 2010 and €1.6 billion in 2009). The notes mature on August 15, 2011, and bear interest based on Euribor with a spread of 0.375%. The Programme is perpetual. As a bond issue matures, the principal amount of that bond becomes available for new issuances under the Programme. We have eliminated the currency exposure arising from the notes by hedging the notes into U.S. dollars and fixing the interest rates at a range of 5.355% to 5.367%. We translate the debt into U.S. dollars using current exchange rates prevailing at the balance sheet date. The foreign exchange adjustment for the foreign currency denominated notes was $165.4 million and $391.1 million at December 31, 2010 and 2009, respectively.

 

Other Senior Notes:  On March 22, 2010 and April 6, 2010, we issued a combined $1.25 billion aggregate principal amount of 8.625% senior notes due 2015, and $1.5 billion aggregate principal amount of 8.750% senior notes due March 15, 2017, pursuant to an indenture dated as of March 22, 2010. The aggregate net proceeds from the issuances were approximately $2.67 billion after deducting initial purchasers’ discounts and estimated offering expenses. The notes are due in full on their scheduled maturity dates. The notes are not subject to redemption prior to their stated maturity and there are no sinking fund requirements. In connection with the note issuances, we entered into registration rights agreements obligating us to, among other things, complete a registered exchange offer to exchange the notes of each series for new registered notes of such series with substantially identical terms, or register the notes pursuant to a shelf registration statement.

 

Because the registration statement for the exchange offer had not been declared effective by the SEC by January 26, 2011, as required under the registration rights agreement, the annual interest rate on the affected notes increased by 0.25% per year for 90 days, commencing on that date. If (i) we are unable to consummate the exchange offer by April 26, 2011, or (ii) if applicable, a shelf registration statement has not been declared effective or ceases to be effective during the required effectiveness period, the annual interest rate on such notes will increase by an additional 0.25% per year to the maximum additional rate of 0.50% per year. The applicable interest rate will revert to the original level after the exchange offer is consummated.

 

The indentures governing the unsecured bonds and medium-term notes contain customary covenants that, among other things, restrict our and our restricted subsidiaries’ ability to (i)  incur liens on assets; (ii) declare or pay dividends or acquire or retire shares of our capital stock during certain events of default; (iii) designate restricted subsidiaries as non-restricted subsidiaries or designate non-restricted subsidiaries; (iv) make investments in or transfer assets to non-restricted subsidiaries; and (v) consolidate, merge, sell, or otherwise dispose of all or substantially all of our assets.

 

The indenture also provides for customary events of default, including but not limited to, the failure to pay scheduled principal and interest payments on the notes, the failure to comply with covenants and agreements specified in the indenture, the acceleration of certain other indebtedness resulting from non-payment of that indebtedness, and certain events of insolvency. If any event of default occurs, any amount then outstanding under the senior notes may immediately become due and payable.

 

Unsecured Bank Debt

 

Revolving Credit Facilities:  In October 2010, using cash on hand, we repaid and terminated our $2.0 billion unsecured revolving credit facility, scheduled to expire on October 14, 2010. This floating rate obligation had an interest rate of 0.91% at the time of repayment.

 

As of December 31, 2010, $234.6 million of unsecured loans were outstanding under our credit agreement dated as of October 13, 2006. These loans are held by lenders not party to the April 2010 amendment of such facility and remain unsecured and mature in October 2011 on the original maturity date for this credit facility. Effective as of December 22, 2010, we amended such credit agreement to revise the definition of fixed charge coverage ratio to add to earnings impairment charges and fair value adjustments incurred during such period to the extent they were

deducted from earnings. In conjunction with the amendment, we repaid $110.4 million of the unsecured loans and, as of December 31, 2010, $234.6 million of the loans remained outstanding. See “Secured Bank Debt” above.

 

On January 31, 2011, we entered into a new $2.0 billion unsecured three-year revolving credit facility with a group of 11 banks that will expire on January 31, 2014. This revolving credit facility provides for interest rates based on either a base rate or LIBOR plus an applicable margin determined by a ratings-based pricing grid. The credit agreement contains customary events of default and restrictive financial covenants that require us to maintain a minimum fixed charge coverage ratio, a minimum consolidated tangible net worth and a maximum ratio of consolidated debt to consolidated tangible net worth. As of March 4, 2011, no amounts were outstanding under this revolving facility.

 

Term Loans:  From time to time, we enter into funded bank financing arrangements. During 2010, we repaid in full all such outstanding term loans, and such payments aggregated $485 million.

 

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 had a call option date of December 21, 2010, and the $400 million tranche has a call option date of December 21, 2015. We did not exercise the call option at December 21, 2010 and the interest rate on the $600 million tranche changed from a fixed interest rate of 5.90% to a floating rate with an initial credit spread of 1.55% plus the highest of (i) 3 month LIBOR; (ii)  10-year constant maturity treasury; and (iii) 30-year constant maturity treasury. The interest will reset quarterly. The $400 million tranche has a fixed interest rate of 6.25% until the 2015 call option date, and if we do not exercise the call option, the interest rate will change to a floating rate, reset quarterly, based on the initial credit spread of 1.80% plus the highest of (i) 3 month LIBOR; (ii) 10-year constant maturity treasury; and (iii) 30-year constant maturity treasury. If we choose to redeem the $600 million tranche, we must pay 100% of the principal amount of the bonds being redeemed, plus any accrued and unpaid interest to the redemption date. If we choose to redeem only a portion of the outstanding bonds, at least $50 million principal amount of the bonds must remain outstanding.

 

Commercial Paper

 

Commercial Paper:  We terminated our $6.0 billion Commercial Paper Program effective May 17, 2010. We had access to the FRBNY Commercial Paper Funding Facility from its inception in 2008 until January 2009.

 

Derivatives

 

We employ 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. At December 31, 2010, 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 swap agreements is that changes in their fair values are recorded in Other comprehensive income (“OCI”) instead of in earnings for 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 swaps and foreign currency swaps 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 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.

Credit Ratings

 

Our current long-term debt ratings impose the following restrictions under our 2004 ECA facility: (i) we must segregate all security deposits, overhaul rentals and rental payments related to the aircraft financed under our 2004 ECA facility into separate accounts controlled by the security trustee (segregated rental payments are used to make scheduled principal and interest payments on the outstanding debt) and (ii) we must file individual mortgages on the aircraft funded under both the 1999 and 2004 ECA facilities in the local jurisdictions in which the respective aircraft are registered.

 

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

 

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:

 

 

Secured Debt Ratings

 

 

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.

 

Existing Commitments

 

The following table summarizes our contractual obligations at December 31, 2010.

 

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 design 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. In prior years, we had determined that we were the primary beneficiary of these entities due to our exposure to the majority of the risks and rewards of these entities and consolidated the entities into our consolidated financial statements. Because we did not have legal or operational control over and did not own the assets of, nor were we directly obligated for the liabilities of these entities, we presented the assets and liabilities of these entities separately on our Consolidated Balance Sheet at December 31, 2009. Assets in the amount of $79.7 million and liabilities in the amount of $6.5 million are included in our 2009 Consolidated Balance Sheet and net expenses of $7.2 million, and $2.3 million are included in our Consolidated Statements of Operations for the years ended December 31, 2009, and 2008, respectively, for these entities. We have a credit facility with these entities to provide financing up to approximately $13.5 million, of which approximately $6.3 million was borrowed at December 31, 2010. The maximum exposure to loss for these entities is $23.0 million, which is the total investments in senior secured notes and total outstanding under the credit facility.

 

Results of Operations

 

Certain amounts have been reclassified in the 2009 and 2008 Consolidated Statements of Operations and Statements of Cash Flows to conform to our 2010 presentation. During the annual and quarterly periods ended December 31, 2010, we changed (i) the presentation of the Provision for overhauls from operating expenses to a reduction of Rental of flight equipment revenues and (ii) the presentation of the impairment charges, fair value adjustments and lease related charges recorded in Flight equipment marketing revenues to operating expenses. The details of these classification errors are provided in Note A of Notes to Consolidated Financial Statements for the 2009 and 2008 prior annual periods and in Note V of Notes to Consolidated Financial Statements for the quarterly prior periods.

2010 Compared to 2009

 

Revenues from net rentals of flight equipment decreased 4.1% to $4,726.5 million for the year ended December 31, 2010, from $4,928.3 million for the year ended December 31, 2009. The number of aircraft in our fleet decreased to 933 at December 31, 2010, compared to 993 at December 31, 2009. Revenues from net rentals of flight equipment decreased (i) $206.8 million due to a decrease related to aircraft in service during the year ended December 31, 2009, and either transferred to Flight equipment held for sale or sold prior to December 31, 2010; (ii) $25.6 million due to a decrease in overhaul rentals recognized as a result of an increase in actual and expected overhaul related expenses partly offset by an increase in the number of leases with overhaul provisions; (iii) $63.9 million due to a decrease in lease rates on aircraft in our fleet during both periods, that were re-leased or had lease rate changes between the two periods; and (iv) $13.1 million due to lost revenue relating to aircraft in transition between lessees, primarily resulting from repossessions of aircraft from airlines. These revenue decreases were partially offset by a $107.6 million increase due to the addition of new aircraft to our fleet after December 31, 2009, and aircraft in our fleet as of December 31, 2009 that earned revenue for a greater number of days during the year ended December 31, 2010 than during the year ended December 31, 2009. All aircraft in our fleet were subject to signed lease agreements or signed letters of intent at December 31, 2010.

 

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. As part of our ongoing fleet strategy we sold or agreed to sell 77 aircraft during the year ended December 31, 2010, two of which were accounted for as sales-type leases. For these aircraft, we recorded any impairments or adjustments to fair value in Impairment charges and fair value adjustments on flight equipment to be disposed of (see below for variance analysis of Impairment charges and fair value adjustments on flight equipment sold or to be disposed of). In comparison, we sold nine aircraft during the same period in 2009, three of which were accounted for as a sales-type lease. Three of these nine transactions resulted in gains, and are recorded in Flight equipment marketing and gain on aircraft sales on our Consolidated Statement of Operations. The impairment charges recorded on the remaining six aircraft are recorded in Impairment charges and fair value adjustments on flight equipment sold or to be disposed of.

 

Interest and other revenue increased to $61.7 million for the year ended December 31, 2010, compared to $58.2 million for the year ended December 31, 2009, due to (i) a $7.6 million increase in interest income related to our Notes receivable and Net investment in finance and sales-type leases; (ii) a $5.0 million increase in proceeds received related to total loss of aircraft; (iii) a $1.9 million increase in security deposits forfeitures related to nonperformance by customers; and (vi) other minor increases aggregating $4.1 million. The increases were partially offset by (i) a $7.8 million decrease in foreign exchange gains; and (ii) a $7.3 million decrease in revenues from VIEs, which we consolidated into our 2009 statement of operations and deconsolidated on January 1, 2010.

 

Interest expense increased to $1,567.4 million for the year ended December 31, 2010, compared to $1,365.5 million for the year ended December 31, 2009, as a result of a 0.58% increase in our average composite interest rate, partially offset by a decrease in average outstanding debt (excluding the effect of debt discount and foreign exchange adjustments) to $28.7 billion for the year ended December 31, 2010, compared to $31.1 billion for the year ended December 31, 2009.

Our composite borrowing rates fluctuated as follows from December 2007 to December 2010:

 

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 a loss of $47.8 million and income of $21.5 million for the years ended December 31, 2010 and 2009, primarily due to ineffectiveness recorded on our derivative instruments designated as cash flow hedges. The income effect for the year ended December 31, 2010, also includes $15.4 million of losses on matured derivative contracts compared to gains on matured swaps of $9.7 million for the year ended December 31, 2009. 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 Q of Notes to Consolidated Financial Statements.

 

Depreciation of flight equipment decreased to $1,954.9 million for the year ended December 31, 2010, compared to $1,959.4 million for the year ended December 31, 2009, due to a decrease in the cost of our fleet to $51.6 billion at December 31, 2010 from $57.7 billion at December 31, 2009. The cost of our fleet held for use was reduced by impairment charges recorded during the year and triggered by aircraft being transferred to Flight equipment held for sale, aircraft being sold or deemed likely to be sold, and impairment charges resulting from our recurring recoverability analyses. See below for variance analysis of impairment charges taken.

 

We recorded Impairment charges and fair value adjustments on flight equipment sold or to be disposed of in the amount of $550.0 million for the year ended December 31, 2010, compared to charges of $34.7 million for the year ended December 31, 2009. During the year ended December 31, 2010, we recorded impairment charges and fair value adjustments aggregating $394.9 million related to aircraft that were either reclassified to Flight equipment held for sale or designated for part-out. In addition, we recorded $155.1 million in Impairment charges and fair value adjustments relating to aircraft that were deemed likely to be sold, or sold. The charges for the year ended December 31, 2009 related to impairment charges and fair value adjustments on seven aircraft.

 

Aircraft impairment charges on flight equipment held for use increased to $948.7 million for the year ended December 31, 2010, from $52.9 million for the year ended December 31, 2009. As a result of the December 2010 announcement by Airbus to offer the new narrow body neo aircraft with new fuel efficient engine options, we recorded impairment charges aggregating $557.4 million related to 61 aircraft in our fleet. In addition to these charges, we recorded an additional $391.3 million impairment charges on 17 aircraft in our fleet as a result of our recurring recoverability analyses performed during the year. During the year ended December 31, 2009, we recorded impairment charges of $34.7 million related to seven aircraft that were subsequently sold. We also recorded impairment charges aggregating $52.9 million during the year ended December 31, 2009, relating to our fleet held for use. We recorded no impairment charges during the year ended December 31, 2008. See Note D of Notes to Consolidated Financial Statements.

Selling, general and administrative expenses increased to $212.8 million for the year ended December 31, 2010, compared to $196.7 million for the year ended December 31, 2009, due to (i)  $20.7 million higher pension expenses including out of period adjustments aggregating $20.2 million related to pension expenses covering employee services from 1996 to 2010 and not previously recorded; (ii) a $19.5 million increase in write-offs of notes receivable; and (iii) a $3.5 million increase in impairment charges related to spare parts inventory. These increases were partially offset by (i) a $14.5 million decrease in expenses from VIEs, which we consolidated into our 2009 statement of operations and deconsolidated January 1, 2010 as a result of our adoption of new guidance; (ii) a $10.6 million decrease in aircraft operating expenses stemming from a reduction in expenses realized related to repossessions of aircraft; and (iii) other minor fluctuations aggregating a decrease of $2.5 million.

 

Other expenses for the year ended December 31, 2010 of $91.2 million stem from lease related costs that were expensed as a result of agreements to sell aircraft to third parties that are currently under lease. There were no such comparable expenses for the year ended December 31, 2009.

 

Our effective tax rate for the year ended December 31, 2010 is a tax benefit of 35.2%, as compared with a tax expense of 35.9% for the year ended December 31, 2009. 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 $59.5 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.

 

Accumulated other comprehensive loss was $58.9 million and $138.2 million at December 31, 2010 and 2009, respectively. Fluctuations in Accumulated other comprehensive income are primarily due to changes in market values of cashflow hedges. See Note I of Notes to the Consolidated Financial Statements.

 

2009 Compared to 2008

 

Revenues from net rentals of flight equipment increased 5.3% to $4,928.3 million for the year ended December 31, 2009, from $4,678.9 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 net 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)  $2.9 million due to a straight-line adjustment taken in 2008, which decreased the 2008 lease 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 $6.1 million decrease in overhaul rentals recognized due to an increase in actual and expected overhaul related expenses partly offset by an increase in the number of leases with overhaul provisions for the year ended December 31, 2009; (ii) 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; (iii) 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; and (iv) a $14.8 million decrease related to aircraft in service during the year ended December 31, 2008, and sold prior to December 31, 2009. 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 recorded revenue of $15.5 million from flight equipment marketing and gain on aircraft sales for the year ended December 31, 2009, compared to $46.8 million for 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.

 

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 Q 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.

 

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, 2008, consisted of (i) a charge of $18.1 million related to a write down of a secured note to fair value (see Note E 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 other comprehensive income are primarily due to changes in market values of cashflow hedges. See Note I of Notes to the Consolidated Financial Statements.

 

Critical Accounting Policies and Estimates

 

Our Management’s discussion and analysis of financial condition and results of operations is 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 a recurring basis, we evaluate our estimates, including those related to revenue, including overhaul rentals, flight equipment, derivatives, fair value measurements, and income tax contingencies. We base our estimates on historical experience

and on various other assumptions that are believed to be reasonable under the circumstances. These estimates 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. A summary of our significant accounting policies is presented in Note B to our Consolidated Financial Statements. We believe the following critical accounting policies could have a significant impact on our results of operations, financial position and financial statement disclosures, and may require subjective and complex estimates and judgments.

 

Overhaul Rentals: Under the provisions of all of our leases, lessees are responsible for maintenance and repairs, including major maintenance (overhauls) over the term of the lease. Under the provisions of many of our leases, we receive overhaul rentals based on the usage of the aircraft. For certain airframe and engine overhauls, we reimburse the lessee for costs incurred up to, but not exceeding the overhaul rentals that the lessee has paid to us. We recognize overhaul rentals received as revenue, net of estimated overhaul reimbursements. We estimate expected overhaul reimbursements during the life of the lease, which estimate requires significant judgments. Management determines the estimated future overhaul reimbursement rate based on quantitative and qualitative information including: (i) changes in historical overhaul pay-out rates from period to period; (ii) trends in overhaul reimbursements identified during our quarterly aircraft cost review; (iii) trends in the historical overhaul pay-out percentages for expired leases; (iv) future trends in the industry, including the overhaul model; (v) future estimates of overhaul pay-out rates on leases scheduled to expire; (vi) changes in our business model or aircraft portfolio strategies; and (vii) other factors identified from time to time that effect the future overhaul pay-out percentages. The historical overhaul pay-out rate is subject to significant fluctuations. Using its judgment, management periodically evaluates its overhaul reimbursement rate, and adjusts overhaul rental revenue recognized accordingly. Additionally, as our average fleet age increases, we anticipate that estimated future overhaul reimbursements will increase. If the actual overhaul reimbursements are different than our estimates, there could be a material impact on our results of operations.

 

Flight Equipment: Flight equipment under operating lease is our largest asset class, representing the majority of our consolidated assets for the years ended December 31, 2010 and 2009, respectively. There are several accounting policies that are applicable to our flight equipment that may require subjective and complex estimates and judgments that affect the reported amounts of our flight equipment and the related disclosures, as described below.

 

Recoverability Assessments: Management evaluates flight equipment under operating leases for recoverability on a recurring basis. These recoverability assessments are performed for aircraft that are held for use and aircraft that are deemed more likely than not to be sold. The determination of whether a recoverability assessment must be performed and the performance of the recoverability assessment requires significant judgments and estimates.

 

A recoverability assessment is performed by comparing the estimated future cash flows expected to be generated by the aircraft on an undiscounted basis to the carrying value of the aircraft and is assessed at the lowest level of identifiable cash flows, which for us is usually at the individual aircraft level. If the estimated aggregate future undiscounted cash flows exceed the carrying value of the aircraft, the carrying value of the aircraft is considered recoverable and no impairment is recorded. If the carrying value of the aircraft exceeds the estimated aggregate future undiscounted cash flows, the aircraft is deemed not recoverable, then management is required to determine the aircraft’s fair value and record an impairment charge equal to the difference between the carrying value of the aircraft and its fair value. When determining recoverability of aircraft in accordance with GAAP, management does not consider materiality. We only record an impairment loss if and when the carrying value of the aircraft exceeds the aircraft’s estimated aggregate future undiscounted cash flows.

 

Recurring Recoverability Assessment: Management evaluates quarterly the need to perform a recoverability assessment of held for use aircraft considering the requirements under GAAP and performs this assessment at least annually for all aircraft in our fleet. Recurring recoverability assessments are performed whenever events or changes in circumstances indicate that the carrying amount of our aircraft may not be recoverable, which may require us to change our assumptions related to future estimated cash flows. These events or changes in circumstances considered include potential sales, changes in contracted lease terms, changes in the status of a lease, re-lease, not subject to lease, changes in portfolio strategies, changes in demand for a particular aircraft type

and changes in economic and market circumstances. Economic and market circumstances include the risk factors affecting the airline industry, as disclosed in Item 1A Risk Factors — Overall Airline Industry Risk.

 

The undiscounted cash flows in the recoverability assessment consist of cash flows from currently contracted leases, future projected lease cash flows, including contingent rentals and an estimated disposition value, as appropriate, for each aircraft. Management is very active in the aircraft leasing industry and develops the assumptions used in the recoverability assessment 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 assumptions of undiscounted cash flows developed are estimates and may change due to: (i) changes in contracted lease rates due to restructuring of lease payments and terms of leases and changes in lease term due to early termination and extension of leases; (ii) changes in future lease rates and residual values due to demand for a particular aircraft type caused by risk factors affecting the airline industry; (iii) changes in lease rates and disposition values caused by the global economic environment; (iv) changes in the anticipated time period that an aircraft can be economically leased; (v) changes in the timing of disposal or planned disposal of aircraft in the fleet; and (vi) changes in how the aircraft will be deployed in our business. In the event that an aircraft does not meet the recoverability assessment, 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.”

 

In our recoverability assessment we identify aircraft in our fleet that are most susceptible to impairment, which are those aircraft that management considers to have estimated future undiscounted cash flows that are sufficiently close to their carrying values, but not less than their carrying values, that warrant further evaluation. These aircraft are typically older less in demand aircraft that generally have lower lease rates and are therefore more sensitive to changes in the estimates of future undiscounted cash flows. As of December 31, 2010, we identified 63 aircraft that were most susceptible to failing the recoverability assessment. Of the 63 aircraft identified, two aircraft did not pass the full undiscounted recoverability assessment and a corresponding impairment was recognized for the year ended December 31, 2010. The remaining 61 aircraft passed the recoverability assessment with aggregate undiscounted cash flows exceeding the carrying value of aircraft between 0.2% and 197%, which represents a 22% excess above the net carrying value of those aircraft. These 61 aircraft had an aggregate net book value of approximately $3.4 billion at December 31, 2010. As of December 31, 2010 Management believes that the carrying values of these aircraft as well as all other aircraft in its fleet are supported by the estimated future aggregate undiscounted cash flows expected to be generated by each aircraft. Management believes a full recovery of the airline industry may not be imminent and lower future lease rates and increased costs associated with repossessing and redeploying aircraft may continue to have a negative impact on our operating results in 2011, including causing future potential aircraft impairment charges.

 

We recorded aggregate impairment charges of approximately $948.7 million related to 78 aircraft in our fleet held for use in connection with our recoverability assessments for the year ended December 31, 2010. See Item 7 — Overview for details of the 2010 impairment charges.

 

Recoverability Assessments — Potential Sales: Management evaluates quarterly the need to perform recoverability assessments of all contemplated aircraft sale transactions considering the requirements under GAAP. The recoverability assessment is performed if events or changes in circumstances indicate that it is more likely than not that an aircraft will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. Due to the significant uncertainties of potential sales transactions Management must use its judgment to evaluate whether a sale is more likely than not. The factors that Management considers in its assessment include (i) the progress of the potential sales transactions through a review and evaluation of the sales related documents and other communications, including, but not limited to, letters of intent or sales agreements that have been negotiated or executed, (ii) the general or specific ILFC fleet strategies, liquidity requirements and other business needs and how those requirements bear on the likelihood of sale, and (iii) the evaluation of potential execution risks, including the source of potential purchaser funding and other execution risks.

 

The undiscounted cash flows in the more likely than not sales recoverability assessment will depend on the structure of the potential sale transaction and may consist of cash flows from currently contracted leases, including contingent rentals, and the estimated proceeds from sale. In the event that an aircraft does not meet the more likely than not sales recoverability assessment, the aircraft will be recorded at fair value, which in almost all of our

potential sales transactions is based on the value of the sales transaction, resulting in an impairment charge. We record the impairment charge and other costs of sales in Selling, general and administrative, or if material, present it separately on our Consolidated Statement of Operations.

 

Flight Equipment Held for Sale: We classify aircraft as Flight equipment held for sale when all the criteria under GAAP are met. Aircraft classified as Flight equipment held for sale are recorded at the lower of their carrying amount or estimated fair value less estimated costs to sell. If the carrying value of the aircraft exceeds its estimated fair value, then a fair value adjustment is recognized in Selling, general and administrative, or if material, presented separately on our Consolidated Statements of Operations. We cease recognizing depreciation at the time the aircraft is transferred to Flight equipment held for sale.

 

Management evaluates all contemplated aircraft sale transactions to determine whether all the required criteria have been met under GAAP to classify aircraft as Flight equipment held for sale. Management uses judgment in evaluating these criteria. Due to the significant uncertainties of potential sale transaction, the held for sale criteria generally will not be met unless the aircraft is subject to a signed sale agreement, or management has made a specific determination and obtained appropriate approvals to sell a particular aircraft or group of aircraft. At the time aircraft are sold, or classified as Flight equipment held for sale, the cost and accumulated depreciation are removed from the related accounts.

 

We recorded aggregate impairment charges and fair value adjustments related to 77 aircraft sold or to be disposed of approximately $550.0 million, which includes aircraft that we deemed as either more likely than not to be sold or classified as held for sale for the year ended December 31, 2010. See Item 7 — Overview for details of these 2010 impairment charges.

 

Depreciable Lives and Residual Values: 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 using the straight-line method to a zero residual value over its useful life of 35 years. We review the residual values of our aircraft periodically to determine if those values are appropriate, including aircraft that have been impaired and aircraft that are out of production. When a residual value changes we adjust our depreciation rates on a prospective basis. Any change in the assumption of useful life or residual values could have a significant impact on our results of operations.

 

Derivative Financial Instruments

 

We employ a variety of derivative instruments to manage our exposure to interest rate and foreign currency risks. Derivatives are recognized on our Consolidated Balance Sheets at their fair values. We obtain our derivative fair values on a quarterly basis from AIG. When hedge accounting treatment is achieved for a derivative, the changes in fair value related to the effective portion of the hedge is recognized in other comprehensive income or in current period earnings, depending on the designation of the derivative as a cash flow hedge or a fair value hedge. The ineffective portion of the hedge is recognized in income. At the time the derivative is designated as a hedge, we select a method of effectiveness assessment, which we must use for the life of the hedge. We use the “hypothetical derivative method” for all of our hedges when we assess effectiveness. This method involves establishing a hypothetical derivative that mirrors the hedged item, but has a zero-value at the hedge designation date. The cumulative change in fair value of the actual hedge derivative instrument is compared to the cumulative change in the fair value of the hypothetical derivative. The difference between these two amounts is the calculated ineffectiveness and is recorded in current period earnings.

 

Fair Value Measurements

 

Fair value is defined as 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 values of our derivatives on a recurring basis. Our derivatives are not traded on an exchange and are therefore inherently more difficult to value. AIG provides us with the recurring fair value 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. Valuation adjustments may be made in the determination of

fair value. These adjustments include amounts to reflect counterparty credit quality and liquidity risk, and are as follows:

 

 

We measure the fair value of aircraft 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 our aircraft may not be recoverable. We principally use the income approach to measure the fair value of our aircraft. The income approach is based on the present value of cash flows from contractual lease agreements and projected future lease payments, including contingent rentals where appropriate, 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. The cash flows used in the fair value estimate are consistent with those used in the recurring recoverability assessment and subject to the same judgments. See Recurring Recoverability Assessments above for further discussion.

 

Lease Revenue

 

We lease flight equipment principally under operating leases and recognize rental revenue ratably over the life of the lease. The difference between the rental revenue recognized and the cash received under the provisions of our leases is included in Lease receivables and other assets on our Consolidated Balance Sheets. Past-due rental revenue is recognized on the basis of management’s assessment of collectability. Management monitors all lessees that are behind in lease payments and discusses relevant operational and financial issues faced by our lessees with our marketing executives to determine the amount of rental revenue to recognize for past due amounts. Our customers make lease payments in advance and we generally recognize rental revenue only to the extent we have received payments or hold security deposits.

 

Income Taxes

 

We are included in the consolidated federal income tax return of AIG. Our provision for federal income taxes 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 we estimate that they will be 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.

 

We have uncertain tax positions consisting primarily of benefits from our FSC and ETI. We recognize uncertain tax benefits only to the extent that it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.

New Accounting Pronouncements

 

Recent Accounting Pronouncements:

 

We adopted the following accounting standards during 2010:

 

Accounting for Transfers of Financial Assets:  In June 2009, the FASB issued an accounting standard addressing transfers of financial assets that, among other things, removes the concept of a qualifying special purpose entity (“QSPE”) from the FASB ASC and removes the exception from applying the consolidation rules to QSPEs.

 

Consolidation of Variable Interest Entities:  In June 2009, the FASB issued an accounting standard that amended the rules addressing the consolidation of VIEs, with an approach focused on identifying which enterprise has the power to direct the activities of a VIE that most significantly affect the entity’s economic performance and has (i) the obligation to absorb losses of the entity or (ii) the right to receive benefits from the entity.

 

Measuring Liabilities at Fair Value:  In August 2009, the FASB issued an accounting standards update to clarify how to apply the fair value measurement principles when measuring liabilities carried at fair value.

 

Subsequent Events:  In February 2010, the FASB amended a previously issued accounting standard to require all companies that file financial statements with the SEC to evaluate subsequent events through the date the financial statements are issued. The standard was further amended to exempt these companies from the requirement to disclose the date through which subsequent events have been evaluated.

 

Disclosures of the Credit Quality of Financing Receivables and the Allowance for Credit Losses: In July 2010, the FASB issued an accounting standards update to require enhanced, disaggregated disclosures regarding the credit quality of financing receivables and the allowance for credit losses.

 

For further discussion of these recent accounting standards, accounting standards adopted in prior years, 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 employ a variety of derivative instruments to manage our exposure to interest rate and foreign currency risks. 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, 2010 and 2009. 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, 2010 and 2009. The VaR increased, primarily due to an increase in the

average duration of our outstanding debt and a decrease in the value of Flight equipment under operating leases due to sales and impairment charges and fair value adjustments.

 

ILFC Market Risk

 

 

 

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

 

 

None.

 

 

 

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 Chief Executive Officer and the Senior Vice President and Chief Financial Officer (collectively the “Certifying Officers”), as appropriate, to allow timely decisions regarding required disclosure.

 

In conjunction with the close of each fiscal quarter, we conduct a review and evaluation, under the supervision and with the participation of our management, including the Certifying Officers, of 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. Based on that evaluation, our Certifying Officers have concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of December 31, 2010, the end of the year covered by this annual report.

 

 

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, 2010 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, 2010, 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 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 have operational control. Our assessment of disclosure controls and procedures, as described above, includes the assessment of those VIEs.

 

 

There have been no changes in our internal controls over financial reporting during the quarter ended December 31, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

None.

 

 

Aggregate fees for professional services rendered to us by PricewaterhouseCoopers LLP (“PwC”) for the years ended December 31, 2010 and 2009 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: