ITEM 1. BUSINESS
INTRODUCTION
Morgan Stanley Aircraft Finance ("MSAF", and together with its subsidiaries, "MSAF GROUP") is a special-purpose statutory business trust formed on October 30, 1997 under the laws of Delaware for an unlimited duration for certain limited purposes. These limited purposes include (1) owning all of the equity interest in various aircraft-owning subsidiaries and (2) acquiring, financing, re-financing, owning, leasing, re-leasing, selling, maintaining and modifying the aircraft and any additional aircraft that MSAF acquires in the future. MSAF group may also enter into certain hedging contracts as described under "Interest Rate Risk Management" and establish and provide loans or guarantees to, or in respect of, its subsidiaries and any entities that may be established or acquired in the future in connection with acquisitions of additional aircraft.
MSAF group's portfolio of aircraft assets consists of 61 aircraft and one engine. The aggregate appraised value of this portfolio was $1,911.2 million as of September 30, 2000. Based on the appraised values as of September 30, 2000, no one aircraft accounts for more than 5% of our portfolio. As of February 15, 2001, we had 60 lease contracts in effect with 42 lessees based in 27 countries, and two aircraft off-lease. As of February 15, 2001, the weighted average remaining contracted lease term of the portfolio (weighted by appraised values as of September 30, 2000 and without giving effect to existing non-binding letters of intent, purchase options or extension options) was 34.1 months. The longest lease is scheduled to expire in September 2013. Therefore, MSAF group will be required to re-lease each of the aircraft one or more times prior to the final maturity date for its notes.
International Lease Finance Corporation ("ILFC") acts as servicer to all of the aircraft in MSAF's portfolio. Among other things, ILFC markets the portfolio for lease or sale and monitors lessee compliance with lease payment, maintenance and insurance terms. MSAF acquired all but two of the aircraft in the portfolio from ILFC. MSAF acquired the remaining two from an affiliate of GE Capital Corporation.
MSAF has funded the acquisition of its aircraft by the issuance and sale of securitized notes, which it issued pursuant to an indenture between MSAF and Bankers Trust Company, as trustee, dated March 3, 1998.
On March 3, 1998 MSAF issued $1,050 million of notes due March 15, 2023 in five subclasses: subclass A-1, subclass A-2, subclass B-1, subclass C-1 and subclass D-1 (collectively, the "1998 Notes"). On March 15, 2000, MSAF issued $1,310 million of notes due March 15, 2025 in five subclasses: subclass A-3, subclass A-4, subclass A-5, subclass B-2 and subclass C-2 (collectively, the "2000 Notes"). MSAF used the proceeds from the issuance and sale of the 2000 Notes in part to redeem $400 million, the entire amount, of its subclass A-1 notes. The 2000 Notes rank equally in right of payment of principal and interest with the corresponding subclasses of 1998 Notes.
The offerings of the 1998 Notes and the 2000 Notes were initially each on a basis exempt from registration under the Securities Act of 1933. During 1998, MSAF filed a registration statement with the Securities and Exchange Commission with respect to an exchange offer of registered 1998 Notes with terms virtually identical to those of the previously restricted 1998 Notes. This registration statement was declared effective on January 12, 1999 and the exchange offer was consummated on January 18, 1999. During 2000, MSAF filed a registration statement with the Securities and Exchange Commission with respect to an exchange offer of registered 2000 Notes with terms virtually identical to those of the previously restricted 2000 Notes. This registration statement was declared effective on October 31, 2000 and the exchange offer was consummated on December 4, 2000.
There are seven trustees of MSAF: a Delaware trustee, two independent trustees and four controlling trustees. The controlling trustees manage MSAF. The controlling or independent trustees or directors, as applicable, of each aircraft-owning subsidiary are the same persons as the controlling trustees and the independent trustees of MSAF, unless any provisions of local law mandating a particular citizenship for trustees or directors require otherwise. The initial controlling trustees and independent trustees were appointed by a subsidiary of MSDW. Any succeeding or additional controlling trustees and independent trustees will be appointed by a majority of the then standing controlling trustees. Transactions or proceedings involving certain insolvency proceedings of MSAF may only be approved by a unanimous vote of all controlling trustees and all independent trustees.
MSAF Holdings, an indirect wholly owned subsidiary of Morgan Stanley Dean Witter & Co. ("MSDW"), holds 100% of the beneficial interest in MSAF group. MSAF Holdings may transfer all or a portion of its beneficial interest in MSAF group to a third party in the future.
MSAF group's registered office is located at 1100 North Market Street, Rodney Square North, Wilmington, Delaware 19890-0001 care of Wilmington Trust Company, attention: Corporate Trust Administration and its telephone number is 302-651-1000.
RISK FACTORS
THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING MSAF OR THE NOTES. ADDITIONAL RISKS AND UNCERTAINTIES THAT WE ARE NOT AWARE OF AT PRESENT, OR THAT WE BELIEVE TODAY ARE IMMATERIAL, MAY ALSO IMPAIR OUR BUSINESS OPERATIONS OR THE NOTES.
IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, WE MAY NOT BE ABLE TO MAKE THE REQUIRED PAYMENTS ON THE NOTES. IN ADDITION, IT IS POSSIBLE THAT THE RENTAL PAYMENTS UNDER THE LEASES MAY NOT BE ADEQUATE TO MAKE THE REQUIRED PAYMENTS ON THE NOTES.
THIS INFORMATION ALSO CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. IN MOST CASES, YOU CAN IDENTIFY FORWARD-LOOKING STATEMENTS BY TERMINOLOGY SUCH AS "MAY," "SHOULD," "EXPECTS," "PLANS," "ANTICIPATES," "BELIEVES," "ESTIMATES," "PREDICTS," "POTENTIAL" OR "CONTINUE" OR THE NEGATIVE OF SUCH TERMS OR SIMILAR TERMINOLOGY. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS. IN EVALUATING THESE STATEMENTS, YOU SHOULD SPECIFICALLY CONSIDER VARIOUS FACTORS, INCLUDING THE RISKS OUTLINED BELOW.
NO SECURITY INTEREST IN AIRCRAFT
Neither the trustee, the security trustee acting on behalf of the holders of the notes and each other secured creditor nor any noteholder has any security interest, mortgage, charge or other similar interest in the aircraft. If there is an event of default, they will not be able to sell the aircraft to repay the notes or exercise similar remedies which they would have if they had a security interest in the aircraft.
NO EXECUTIVE MANAGEMENT--RELIANCE ON THIRD PARTIES TO MANAGE OUR BUSINESS
We have no executive management resources of our own. We therefore rely on several service providers for the leasing and re-leasing of the portfolio and all other executive and administrative responsibilities. If these service providers do not perform their contractual obligations to us, our operations may suffer and we may not be able to repay the notes. We can give no assurance that we will continue our arrangements with these service providers or that the service providers will continue their relationship with us until the notes are paid in full. If a service provider resigns or we terminate its appointment, we may be unable to find suitable replacement service providers that we can engage on suitable terms. Additionally, our appointment of replacement service providers may cause a lowering or withdrawal of the ratings on the notes. You should refer to "The Servicer" under Item 10, and "Corporate Management" under Item 10, for detailed information on the responsibilities delegated to service providers.
CONFLICTS OF INTEREST OF ILFC
ILFC acts as servicer for our portfolio and as such performs certain services including marketing our current portfolio for lease or sale and monitoring lessee compliance with lease terms. ILFC, however, manages a large aircraft portfolio for itself and others and for that reason, it may face conflicts of interest in managing and marketing our portfolio for re-lease or sale. The aircraft it manages for others may compete with our portfolio when they are being marketed for re-lease or sale. ILFC also arranges aircraft financings and lease transactions and advises many airlines (including some lessees and potential lessees). If ILFC cannot resolve a conflict of interest, the conflict could have an adverse effect on our ability to manage, re-lease or sell the portfolio. In that case, we may be unable to make the required payments on the notes.
For a description of ILFC's aircraft management and advisory business, you should refer to "The Servicer" under Item 10.
LIMITATION ON ILFC'S LIABILITY
Our servicing agreement with ILFC contains limitations on its liability for losses caused by its services. There is a risk that we may be unable to recover from ILFC the amount of any losses they cause in performing the services. Additionally, ILFC will not be liable to noteholders for any losses caused by its services.
We describe the liability and other provisions of the servicing agreement under "The Servicer" under Item 10.
CYCLICALITY OF SUPPLY OF AND DEMAND FOR AIRCRAFT AND DEPRESSION OF AIRCRAFT VALUES
The market for commercial jet aircraft is very cyclical and can produce sharp increases and decreases in aircraft values and lease rates. Decreases in aircraft values or lease rates may cause a decrease in our cash flows. Depending on market conditions, we may be unable to sell or re-lease aircraft on terms that allow us to make payments on the notes.
Aircraft values and lease rates depend on various factors that are outside our control. Such factors include, but are not limited to:
- manufacturer production levels and prices for new aircraft;
- general economic conditions affecting lessee operations;
- used aircraft supply;
- passenger demand;
- retirement and obsolescence of aircraft models;
- manufacturers merging or leaving the aircraft industry;
- interest rates and credit availability;
- fuel and other operating costs;
- re-introduction into service of aircraft previously in storage;
- governmental regulations; and
- lack of capacity in the air traffic control system.
In addition to values for aircraft generally, the value of specific aircraft may increase or decrease sharply depending on factors that are not within our control. Such factors include, but are not limited to:
- manufacturer production levels and prices for new aircraft;
- manufacturers merging or leaving the aircraft industry;
- maintenance and operating history of the aircraft;
- number of operators using a type of aircraft;
- legal or regulatory requirements that prevent an aircraft from being re-leased or sold in the condition that it is in; and
- the discovery of manufacturing defects in an aircraft model.
The value of specific aircraft and the cost of after-market support may also depend on the condition of the manufacturer. Current competition between The Boeing Company and Airbus Industrie G.I.E. is also a threat to aircraft values. Boeing and Airbus have increased production to an amount substantially above the long-term requirement implied by industry forecasts. If production is maintained at this level, the
increased supply of new aircraft may depress used aircraft values and lease rates. This development could cause a decrease in our cash flows and adversely affect our ability to make payments on the notes.
ACTUAL MARKET VALUE MAY BE LESS THAN APPRAISED VALUE
Appraised values for aircraft do not necessarily reflect the market value we could obtain for aircraft at a specific time. Appraised values are based on the assumption that there is an "open, unrestricted stable market environment with a reasonable balance of supply and demand". As we describe above, the aircraft market is not always stable and there may be supply and demand imbalances at any one time, especially for specific aircraft types. At the high point in a cycle, the current market value of some aircraft may be at or above their appraised value while the current market value of others may be significantly less than their appraised values. At a low point in the industry cycle, the current market value of most aircraft types is likely to be less (and in many cases, much less) than appraised base values. For these reasons, noteholders should not rely only on appraised values as an indication of the price that we could obtain if we sold an aircraft.
TECHNOLOGICAL RISKS
The availability of newer, more technologically advanced aircraft or the introduction of increasingly stringent noise or emissions regulations may make it more difficult for us to re-lease or sell aircraft. This risk is particularly significant for us given our need to repay principal and interest on the notes over a relatively long period. This will require that many of the aircraft are leased or sold close to the end of their useful economic life. We expect that the extent to which we are able to manage these technological risks through modifications to aircraft and sale of aircraft will be limited.
RISKS RELATING TO ACQUISITION OF ADDITIONAL AIRCRAFT
We may acquire additional aircraft in the future. The cash flows derived from such additional aircraft, together with the cash flows generated by the aircraft in our portfolio, are expected to be the primary source of payment of interest, principal and premium, if any, on the notes. ILFC is not obligated to act as servicer with respect to any additional aircraft we may acquire. We may need to procure additional servicing arrangements with respect to any additional aircraft we acquire, and we cannot assure that any additional servicing arrangements will be with ILFC or on similar terms to the servicing agreement with ILFC.
OPERATIONAL RESTRICTIONS MAY HARM OUR ABILITY TO COMPETE
The indenture and our governing corporate documents impose restrictions on how we operate our business. These restrictions limit our ability to compete effectively in the aircraft leasing market. For example, we cannot grant privileged rental rates to airlines in return for equity investments in such airlines. There are also restrictions on persons to whom we may lease aircraft to and limits on leasing to lessees in specific geographical regions. Most competing aircraft lessors do not operate under similar restrictions.
LESSEE PURCHASE OPTIONS MAY BE EXERCISED AT PRICES BELOW NOTE TARGET PRICE FOR SUCH AIRCRAFT
As of February 15, 2001, eight lessees had outstanding options to purchase a total of ten aircraft, representing 26.7% of the portfolio by appraised value as of September 30, 2000. If these options were exercised on their earliest exercise date, in only one case the purchase option strike price would be below the note target price that we have assumed for the applicable aircraft on the exercise date, by 2.5%. We have assumed in our Base Case that none of the purchase options are exercised. However, there is a risk that lessees could exercise these options and, in particular, at a time when the exercise prices are below the note target price for the aircraft being purchased. Any exercise of such options will affect the amount and timing of principal payments on the notes.
RISKS RELATING TO AIRCRAFT LIENS
Liens may attach to the aircraft in the course of their operation. These liens may impair our ability to repossess, re-lease or sell the aircraft. Liens which secure the payment of airport taxes, customs duties, air navigation charges (including charges imposed by agencies regulating access to air space, such as Eurocontrol), landing charges, crew wages, repairer's charges or salvage attach to the aircraft in the normal course of operation. The amounts which the liens secure may be substantial and may exceed the value of the aircraft against which the lien is asserted. In some jurisdictions, a holder of aircraft liens may have the right to detain, sell or cause the forfeiture of the aircraft. The lessees may not comply with their obligations under the leases to discharge liens arising during the terms of the leases.
FAILURE TO MAINTAIN REGISTRATION OF AIRCRAFT
All of the aircraft which are or will be operated must be registered with an appropriate aviation authority. If an aircraft is operated without a valid registration, the lessee operator or, in some cases, the owner or lessor, may be subject to penalties which may result in a lien being placed on the aircraft. Loss of registration could have other adverse effects, including grounding of the aircraft and loss of insurance, which may have an adverse effect on our ability to make payments on the notes.
INCREASED REGULATION OF AIRCRAFT
The aircraft industry is heavily regulated and aviation authorities may adopt additional regulations in jurisdictions where our aircraft are registered or operated. Any additional regulations (especially relating to aircraft noise and emissions) may cause us to incur significant costs, depress the value of the aircraft and impair our ability to re-lease the aircraft.
LEASING RISKS
WE MAY NOT BE ABLE TO RE-LEASE AIRCRAFT
We may not be able to re-lease aircraft upon expiration of the leases without incurring significant downtime or without adverse effect on the rental rates that we are able to obtain, especially during any period of downturn in demand for aircraft on operating lease. If we cannot re-lease aircraft we may not have enough cash to make payments on the notes. Even if we can re-lease aircraft we may be unable to receive favorable rental rates, especially if there is reduced demand for aircraft on operating lease. Our ability to re-lease aircraft and obtain acceptable lease payments and terms may suffer because of:
- economic conditions affecting the airline industry;
- the supply of competing aircraft and demand for particular types;
- lessor competition; and
- restrictions on our re-leasing flexibility under the indenture.
The number and types of aircraft that, as of February 15, 2001, we had to place with lessees because of lease expirations through November 30, 2005 are presented in the table below, which shows the years in which the leases are contracted to expire, assuming that (1) no lease terminates prematurely and (2) there are no sales of aircraft or purchases of additional aircraft. See "--Risks Relating to Acquisition of Additional Aircraft" above and "--Lease Termination and Aircraft Repossession" below. We will need to re-lease more aircraft if any aircraft become available through premature terminations of leases.
MSAF GROUP LEASE PLACEMENT REQUIREMENT AS OF FEBRUARY 15, 2001
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* As of February 15, 2001, two aircraft were subject to non-binding letters of intent. An A320-200 aircraft due to be available for lease in October 2001 was subject to a non-binding letter of intent with a Canadian lessee. Assuming that this letter of intent resulted in a binding lease agreement in accordance with its terms, we would not be required to re-lease this aircraft until October 2008. A B737-300 aircraft due to be available for lease in January 2002 was subject to a non-binding letter of intent for extended terms with the existing lessee. Assuming that this letter of intent resulted in a binding lease agreement in accordance with its terms, we would not be required to re-lease this aircraft until January 2009.
(-) Includes aircraft currently off-lease.
As illustrated by the table above, over the next five years we will be required to re-lease 53 aircraft and 1 engine, representing 85.0% of the portfolio by appraised value as of September 30, 2000.
LESSEES MAY NOT PERFORM REQUIRED MAINTENANCE
The standards of maintenance observed by our lessees and the condition of the aircraft at the time of sale or lease may affect future values and rental rates from our aircraft. Under the leases, the lessee has the main responsibility to maintain the aircraft and to comply with all applicable governmental requirements. Some lessees may experience periodic difficulties in meeting their maintenance obligations resulting from adverse environmental conditions or financial and labor difficulties. If a lessee fails to perform required or recommended maintenance on an aircraft, the aircraft may be grounded and we may incur substantial costs to restore the aircraft to an acceptable maintenance condition before sale or re-lease. If our lessees do not perform their obligation to maintain the aircraft, we may have to fund maintenance work on the aircraft. Because our maintenance costs are expenses that rank senior to payments on the notes, we may be unable to make payments on the notes if our maintenance costs were to become sufficiently large. In other cases, we may have an obligation to reimburse the lessee or pay some or all of the cost of aircraft maintenance. Our cash resources may not be sufficient both to fund maintenance requirements and make payments on the notes, especially as the aircraft age.
AIRCRAFT INSURANCE MAY NOT BE ADEQUATE
Our lessees have an obligation under the leases to maintain property and liability insurance covering their operation of the aircraft. We can give no assurance that this insurance will be adequate to cover any losses or liabilities that we may incur in our business. For example, the loss or liability from an aviation accident or other catastrophic event may exceed the coverage limits in the policy. Other losses may not be covered by the insurance. There is also a risk that our lessees will not perform their insurance obligations to us, which may mean that insurance will not be available to us. In either case, we may be unable to make payments on the notes if insurance proceeds do not cover losses or liabilities we may incur.
WE MAY BE UNABLE TO OBTAIN REQUIRED LICENSES AND APPROVALS
If we cannot obtain required government licenses and approvals, we may be unable to re-lease or sell aircraft. In that case, our cash flows may be insufficient to make payments on the notes. Several leases require specific licenses, consents or approvals. These include consents from governmental or regulatory authorities to certain lease payments and to the import, re-export or de-registration of the aircraft. There is a significant risk that subsequent legal and administrative changes will increase such requirements or that a consent, once given, will be withdrawn. We may not receive consents needed in connection with future re-leasing or sale of an aircraft
RISK OF LESSEES IN WEAK FINANCIAL CONDITION
There is a significant risk that the lessees may default on their obligations under the leases. If lessees do not make rent and maintenance payments or are significantly in arrears, we will be unable to make payments on the notes. The ability of each lessee to perform its obligations under its lease will depend primarily on its financial condition. A lessee's financial condition may be affected by various factors beyond its control, including competition, fare levels, passenger demand, operating costs, the cost and availability of finance, economic conditions in the countries where the lessees operate and environmental and other governmental regulation of the air transportation business. As a general matter, weakly capitalized airlines are more likely than well capitalized airlines to seek operating leases and at any point in time, noteholders should expect varying numbers of lessees to be experiencing payment difficulties. Many of our lessees are in a weak financial position. Noteholders should expect this to be the case with future lessees. As a result, a large proportion of lessees may consistently be significantly in arrears in their rental payments or maintenance payments.
As of February 15, 2001, seven lessees were in arrears. The ten aircraft on lease to these lessees represented 14.6% of the portfolio by appraised value as of September 30, 2000. The total amount of rental payments and maintenance reserves that were in arrears with respect to these seven lessees was $6.9 million, of which $5.1 million related to rental payments and $1.8 million related to maintenance reserves. MSAF group held security deposits of $5.3 million against these arrears. The arrears amount represented 2.9% of our total annual contracted lease rental payments. The weighted average number of days past due of such arrears was 65 days.
The current level of defaults and lessee arrears should not be seen as representative of future defaults and arrears, particularly if economic conditions deteriorate. Defaults and amounts in arrears may increase as the market for aircraft on operating lease experiences further cyclical downturns, particularly in emerging markets.
LESSEE BANKRUPTCIES
In certain cases, our lessees' financial difficulties may result in bankruptcy. Recently, three of our lessees have filed for bankruptcy.
In January 2000, TransAer, a lessee based in Ireland, restructured rental and maintenance arrears for two A320-200 aircraft into a note payable of $1.4 million. The terms of the restructuring agreement were that amounts totaling $1.4 million would be repaid during June, July and August 2000. None of these restructured arrears were paid. On October 20, 2000, TransAer filed for bankruptcy, with total arrears outstanding of $1.6 million at that date. MSAF group drew down security deposits of $1.0 million against these arrears.
The leases with respect to the two A320-200 aircraft with TransAer were terminated on October 18, 2000. TransAer had been operating one of these aircraft on wet lease to Libyan Arab Airlines, which has detained the aircraft. MSAF group believes that Libyan Arab Airlines has no right to keep possession of the aircraft. ILFC has submitted an insurance claim for the loss of the aircraft, which is currently pending. ILFC also continues to explore recovery options consistent with compliance with U.S. law. MSAF group may incur significant costs and time in resolving this matter. This aircraft represented 1.7% of the portfolio by appraised value as of September 30, 2000. The second A320-200 aircraft was delivered to a new lessee based in Cyprus on February 17, 2001. This aircraft represented 1.5% of the portfolio by appraised value as of September 30, 2000.
On December 6, 2000, National announced that it had voluntarily filed petitions in the U.S. District Court in Wilmington, Delaware for relief under Chapter 11 of the U.S. Bankruptcy Code. MSAF group currently leases one B757-200ER to National, representing 1.6% of the portfolio by appraised value as of September 30, 2000. As of February 15, 2001, National owed rental arrears of $1.1 million against which MSAF group held a security deposit of $0.6 million. It is not yet clear whether National will raise the necessary financing to continue operations.
On January 10, 2001, TWA announced that it and certain of its subsidiaries had voluntarily filed petitions in the U.S. District Court in Wilmington, Delaware for relief under Chapter 11 of the U.S. Bankruptcy Code. TWA also announced that it had reached agreement with American Airlines, in which American Airlines would acquire substantially all the assets of TWA. This agreement is subject to certain regulatory approvals, including that of the bankruptcy court. MSAF group currently has four aircraft on lease to TWA, representing approximately 5.1% of the portfolio by appraised value as of September 30, 2000. The four aircraft are: one Boeing 757-200ER, two MD-83s and one MD-82. As of February 15, 2001, TWA owed rental arrears of $1.3 million against which MSAF group held security deposits of $2.0 million. MSAF group does not yet know whether TWA intends to affirm or reject some or all of these leases in its bankruptcy proceedings or how the agreement between American Airlines and TWA may impact these leases.
LEASE RESTRUCTURINGS
In certain cases, we may respond to the needs of lessees in financial difficulty including, in certain instances, restructuring the applicable leases. Such restructurings may involve reduced rental payments for a specified period (which may be several months). In addition, certain restructurings may involve the voluntary termination of a lease prior to its expiration and the arrangement of subleases from the lessee to another aircraft operator.
In August 1999 we agreed to restructure the arrears of a Brazilian lessee, Passaredo. The restructured amount of $3.7 million was capitalized as a note payable and added to the lessee's conditional sale agreement loan balance, with an extension of the term of the loan. The aircraft on lease to this lessee was an A310-300 and represented 1.4% of the portfolio by appraised value as of September 30, 2000. In conjunction with this restructuring, the obligations under this lease were transferred to a new Brazilian entity, B.R.A. Transportes Aereos, which replaced Passaredo as lessee. B.R.A., however, defaulted on its obligations under this lease and the aircraft was repossessed in April, 2000. The lease had been scheduled to expire in July 2007. The total amount of rental payments in arrears at the date of the repossession was
$1.3 million. There was no security deposit held by MSAF group to offset against the arrears balance. The aircraft was delivered to a new lessee based in the Pacific region on December 18, 2000.
In February 2000, Canadian Airlines announced a debt restructuring and moratorium plan. The plan resulted in the suspension of payments of about $135 million to lenders and aircraft lessors, including MSAF group. In March 2000, we reached an agreement with the lessee to restructure the lease by slightly reducing the lease rate effective from February 2000 and extending the term by four years to May 2010. The lessee's security deposit of $0.3 million was used to fund the February rental. In March 2000, the lessee resumed rental payments. The lessee has also now fully paid its security deposit. At the same time, the lease was assigned to Air Canada. This aircraft, an A320-200, represented 1.5% of the portfolio by appraised value as of September 30, 2000.
VASP, a former Brazilian lessee, defaulted on its obligations under its lease of a B737-300 aircraft and the aircraft was repossessed in May 2000, following legal proceedings against VASP. The aircraft could not be re-leased until it had been deregistered from the Brazilian aircraft registry. Deregistration was completed on February 22, 2001 following protracted legal proceedings against VASP. The lease was scheduled to expire in March 2003. The total amount of rental payments in arrears at the date of the repossession was $0.5 million, against which MSAF group drew down a security deposit of $0.7 million. The aircraft represented 1.0% of the portfolio by appraised value as of September 30, 2000. ILFC is currently remarketing the aircraft.
In July 1999, another former Brazilian lessee, VARIG, negotiated early termination of its lease of a B747-300 aircraft that was scheduled to expire in April 2003. The total amount of rental payments and maintenance reserves due under this lease through July 1999, the date of the termination agreement, was $4.8 million, against which MSAF group drew down a security deposit of $1.1 million. Under the terms of the termination agreement, VARIG is scheduled to repay $10.8 million over eight years to off-set arrears of $4.8 million and approximately $6.0 million for certain maintenance and downtime costs. Provided no default has occurred by October 2005 under this note payable, the total remaining payments will be reduced by approximately $1.1 million on a pro-rata basis between October 2005 and October 2007, the scheduled final payment date under the note payable. As of February 15, 2001, VARIG had made all payments due under the note payable. This aircraft represented 2.2% of the portfolio by appraised value as of September 30, 2000.
A former Mexican lessee, TAESA, defaulted on its obligations under its lease of a B737-400 aircraft, and the aircraft was repossessed in December 1999. The lease was scheduled to expire in May 2001. The total amount of rental payments and maintenance reserves due under the lease at the date of repossession was $0.6 million. This amount was partially offset by a security deposit of $0.5 million. On February 21, 2000, a court in Mexico declared TAESA bankrupt. It is uncertain whether we will be able to recover the $0.1 million outstanding from TAESA. This aircraft, which represented 1.1% of the portfolio by appraised value as of September 30, 2000, is currently on lease to Travel Service, a carrier based in the Czech Republic.
EMERGING MARKET RISKS
"Emerging markets" are countries that have poorly developed economies that are vulnerable to economic and political problems, such as significant fluctuations in GDP, interest rates and currency exchange rates and civil disturbances, governmental instability, nationalization and expropriation of private assets and the imposition of taxes or other charges by governments. The resulting instability may affect the ability of lessees that operate in these emerging markets to meet their lease obligations and they may be more likely to default than lessees that operate in developed economies. As of February 15, 2001, eleven lessees, representing 28.55% of the portfolio by appraised value as of September 30, 2000, operated in "emerging markets" according to the Morgan Stanley Capital International ("MSCI") designations that we follow under our indenture. In addition, eight lessees representing 17.17% of the portfolio by appraised
value as of September 30, 2000 operated in markets which may be considered to be emerging markets but are categorized as "Other" by the MSCI classification: Air Atlanta Icelandic, Air Macau, Air Malta, Air Mauritius, Air Pacific (Fiji), Cyprus Airways, Icelandair and Lithuanian. In total we lease 45.72% of our portfolio to 19 lessees operating in emerging markets.
As of February 15, 2001, three of the seven lessees in arrears, representing 4.4% of the portfolio by appraised value as of September 30, 2000, were based in emerging markets. The total amount of rental payments and maintenance reserves that were in arrears with respect to these three lessees was $2.8 million, of which $2 million related to rental payments and $0.8 million related to maintenance reserves. MSAF group held security deposits of $1.7 million against these arrears. The weighted average number of days past due for such arrears was 39 days.
In addition, seven of our former lessees whose leases terminated early due to defaults were based in what we consider to be emerging markets. In each case, ILFC was able to repossess the aircraft without recourse to legal action. These seven lessees were based in Brazil, Mexico, Turkey, Guyana and Russia.
RISK OF REGIONAL ECONOMIC DOWNTURNS AFFECTING LESSEES' FINANCIAL CONDITION
There is a significant risk that the economic conditions in the regions where our lessees operate will affect their ability to meet their lease obligations. The commercial aviation industry is very sensitive to general economic conditions. Since air travel is largely discretionary, the industry tends to suffer severe financial difficulties during slow economic periods. Below is a discussion of the regional concentrations of our lessees and the economic characteristics of the various regions that may impact the lessees' financial condition. The regions discussed below are based on designations published by Morgan Stanley Capital International.
EUROPE (DEVELOPED)
MSAF group currently leases 23.1% of the portfolio by appraised value as of September 30, 2000 in the Europe (Developed) region. One of the seven lessees in arrears as of February 15, 2001 is based in this region.
As of February 15, 2001, Air Europa, a lessee based in Spain, owed rental and maintenance arrears of $0.4 million against which MSAF group held a security deposit of $0.5 million. This aircraft represented 1.2% of the portfolio by appraised value as of September 30, 2000.
NORTH AMERICA (DEVELOPED)
MSAF group currently leases 15.4% of the portfolio by appraised value as of September 30, 2000 in the North America (Developed) region. Two of the seven lessees in arrears as of February 15, 2001 are based in the North America region.
As of February 15, 2001, TWA, a lessee based in the United States, owed rental arrears of $1.3 million against which MSAF group held security deposits of $2.0 million. On January 10, 2001, TWA announced that it and certain of its subsidiaries had voluntarily filed petitions in the U.S. District Court in Wilmington, Delaware for relief under Chapter 11 of the U.S. Bankruptcy Code. TWA also announced that it had reached agreement with American Airlines in which American Airlines would acquire substantially all the assets of TWA. This agreement is subject to certain regulatory approvals, including that of the bankruptcy court. MSAF group currently has four aircraft on lease to TWA, representing approximately 5.1% of the portfolio by appraised value as of September 30, 2000. The four aircraft are: one Boeing 757-200ER, two MD-83s and one MD-82. MSAF group does not yet know whether TWA intends to affirm or reject some or all of these leases in its bankruptcy proceeding or how the agreement between American Airlines and TWA may impact these leases.
As of February 15, 2001, National, a lessee based in the United States, owed rental arrears of $1.1 million against which MSAF group held a security deposit of $0.6 million. MSAF group currently leases one B757-200ER to National, representing 1.6% of the portfolio by appraised value as of September 30, 2000. On December 6, 2000, National announced that it had voluntarily filed petitions in the U.S. District Court in Wilmington, Delaware for relief under Chapter 11 of the U.S. Bankruptcy Code. It is not yet clear whether National will raise the necessary financing to continue operations.
PACIFIC (DEVELOPED)
MSAF group currently leases 13.1% of the portfolio by appraised value as of September 30, 2000 in the Pacific (Developed) region. As of February 15, 2001, none of the lessees in this region were in arrears.
EUROPE AND MIDDLE EAST (EMERGING)
MSAF group currently leases 7.7% of the portfolio by appraised value as of September 30, 2000 in the Europe and Middle East (Emerging) region. Three of the seven lessees in arrears as of February 15, 2001 are based in this region.
As of February 15, 2001, Air Alfa, a lessee based in Turkey, owed total arrears of $2.7 million, of which $2.0 million related to rental payments and $0.7 million related to maintenance reserves. MSAF group held a security deposit of $0.7 million against these arrears. The lessee is unable to cure its payment defaults and as a result in February 2001 ILFC commenced repossession proceedings. This aircraft, an A321-100, represented 2.0% of the portfolio by appraised value as of September 30, 2000.
As of February 15, 2001, Travel Service, a lessee based in the Czech Republic, owed rental arrears of $0.03 million, against which MSAF group held a security deposit of $0.5 million. This aircraft, a B737-400, represented 1.1% of the portfolio by appraised value as of September 30, 2000.
As of February 15, 2001, Olympic, a lessee based in Greece, owed maintenance arrears of $0.1 million, against which MSAF group held a security deposit of $0.5 million. This aircraft, a B737-400, represents 1.3% of the portfolio by appraised value as of September 30, 2000.
ASIA (EMERGING)
MSAF group currently leases 15.9% of the portfolio by appraised value as of September 30, 2000 in the Asia (Emerging) region. As of February 15, 2001, none of the lessees in this region were in arrears.
LATIN AMERICA (EMERGING)
MSAF group currently leases 5.0% of the portfolio in Latin America (all in Mexico) by appraised value as of September 30, 2000. As of February 15, 2001, none of the lessees in this region were in arrears.
OTHER
MSAF group currently leases 17.2% of the portfolio by appraised value as of September 30, 2000 in the Other region. One of the seven lessees in arrears as of February 15, 2001 is based in this region.
As of February 15, 2001, Air Atlanta Icelandic, a lessee based in Iceland, owed total arrears of $1.3 million, of which $0.5 million related to rental payment and $0.8 million related to maintenance reserves. MSAF group held a security deposit of $0.5 million against these arrears. The aircraft, a B747-300B, represented 2.2% of the portfolio by appraised value as of September 30, 2000.
LEASE TERMINATION AND AIRCRAFT REPOSSESSION
If a lessee defaults, we have the right to terminate the lease and repossess the aircraft under the terms of each lease. However, it may be difficult, expensive and time-consuming to enforce our rights if the lessee
contests such termination or is bankrupt or under court protection. ILFC may incur significant costs on our behalf in trying to repossess an aircraft and in performing maintenance work necessary to make the aircraft available for re-lease or sale. Further, our efforts to repossess an aircraft may be limited by the laws of the local jurisdiction which may delay or prevent us from repossessing an aircraft following a lessee's default.
RISKS RELATING TO PAYMENTS ON THE NOTES
ACTUAL EXPERIENCE MAY NOT MATCH OUR ASSUMPTIONS
We have determined the expected final payment dates for the notes based on assumptions about our future cash flows and interest and operating costs and possible future economic conditions. The purpose of these assumptions is to illustrate the payment provisions of the notes. Many of these assumptions relate to future political, economic and market conditions (for example, lease rates) that are outside our control and are difficult or impossible to predict. Other assumptions relate to future events (for example, maintenance payments) that depend on the actions of lessees or others with whom we conduct business. For this reason, it is highly unlikely that our experience in the future will be consistent with these assumptions. As a result, we are highly likely to be unable to make payments on the notes at the times and in the amounts that the assumptions indicate.
SUBORDINATION PROVISIONS
Expenses and certain other payments are senior in priority of payment to the notes and are paid out before any payments are made on the notes. Under certain circumstances, the rights of the noteholders, as holders of each subclass of notes, to receive payments of principal in respect of such subclass of notes and to exercise remedies upon default will be subordinated to the rights of the noteholders with respect to the most senior subclass of notes then outstanding. If an event of default with respect to any subclass of notes occurs under the indenture, the security trustee has the exclusive right to exercise and enforce any and all remedies with respect to the collateral held by MSAF group. Therefore, if an event of default occurs, the holders of each subclass of notes will not be permitted to enforce certain rights until all amounts owing under any more senior notes outstanding and certain other amounts have been paid in full.
CAPITAL MARKETS RISKS
TRADING MARKET FOR THE NOTES
Morgan Stanley & Co. Incorporated currently makes a market in the notes. However, it is not obligated to do so, and any such market making may be discontinued at any time without notice, in its sole discretion. Therefore, we can give no assurance as to the liquidity of, or the trading market for, the notes.
WE MAY BE UNABLE TO REFINANCE THE SUBCLASS A-3, A-4 OR B-2 NOTES
We intend to refinance the subclass A-3, A-4 and B-2 notes on their expected final payment dates. Our ability to do so will depend on many factors outside our control, including general conditions in the capital markets and market perceptions of the commercial aviation industry, the aircraft leasing business generally and our own performance. If we are unable to refinance the subclass A-3, A-4 or B-2 notes on their expected final payment dates, they will remain outstanding until they are refinanced or otherwise paid off in accordance with their terms. Depending on the factors referred to above and how quickly we are subsequently able to refinance the notes, these subclasses of notes may remain outstanding for a significant period.
BANKRUPTCY RISKS
We have taken steps to structure MSAF to ensure that our assets are not consolidated with MSDW's or any of its affiliates' assets or otherwise become available to MSDW's or any of its affiliates' creditors in any bankruptcy or insolvency proceeding involving MSDW.
If MSDW or any of its affiliates becomes bankrupt or insolvent, there is a legal risk that a court or other authority could decide that these steps were not effective to insulate our assets from MSDW's assets. As a result, the aircraft and our other assets could become available to repay both MSDW's creditors and our creditors, including noteholders. We could also lose all of our rights in the aircraft and our other assets. In either case, it may be impossible to repay amounts outstanding under the notes.
TAX RISKS
Neither the trustee nor MSAF will make any additional payments to noteholders in respect of any withholding or deduction required to be made by applicable law with respect to payments made on the notes. In the event that MSAF is or will be required to make a withholding or deduction, it will use reasonable efforts to avoid the application of such withholding taxes and may in certain circumstances redeem the notes in the event such withholding taxes cannot be avoided. In the event any withholding taxes are imposed with respect to the notes and MSAF does not redeem the notes, the net amount of interest received by noteholders will be reduced by the amount of the withholding or deduction.
MSAF believes that it will not become subject to any material taxes in any of the jurisdictions in which any of the lessees are organized or operate under the present tax laws of such jurisdictions. However, there can be no assurance that other leases to which MSAF group may become a party as a result of the re-leasing of the aircraft or acquisition of additional aircraft will not result in the imposition of withholding or other taxes.
THE PORTFOLIO
All of our assets consist of 100% of the equity in the aircraft-owning subsidiaries and certain leasing subsidiaries and certain loans made to the aircraft-owning subsidiaries. We indirectly own (1) the portfolio, (2) the rights under the related leases, and (3) cash and cash equivalents on deposit.
APPRAISALS
As of September 30, 2000, our portfolio had an aggregate appraised value of $1,911.2 million. Under our indenture, we are required, at least once each year and in any case no later than October 31 of each year, to deliver to the trustee appraisals of the base value of each of the aircraft in our portfolio from at least three independent appraisers that are members of the International Society of Transport Aircraft Trading or any similar organization. The annual appraisals for 2000 were submitted to the trustee and filed with the Securities and Exchange Commission on Form 8-K on October 31, 2000.
Three appraisers, Aircraft Information Services, Inc., BK Associates, Inc. and Airclaims Limited, have provided appraisals of the value of each of our aircraft at normal utilization rates in an open, unrestricted and stable market, without taking into account the value of related leases, maintenance reserves or security deposits as of September 30, 2000, adjusted to account for the reported maintenance standard of the aircraft. The appraisals were not based on a physical inspection of the aircraft.
The average appraised value of each aircraft as of September 30, 2000, used in calculating the "Adjusted Portfolio Value" under the indenture, is calculated by taking the average of the most recent appraised values obtained from the three appraisers. Under the indenture, if on any payment date 105% of the Adjusted Portfolio Value is not greater than the assumed Portfolio Value on that payment date, MSAF's excess cash flows, after paying the interest and Minimum Principal Payment Amount due on its outstanding notes on that date, are redirected to be repaid as the Scheduled Principal Payment Amount of the Class A notes. The Adjusted Portfolio Values resulting from the receipt of these appraisals do not cause such a redirection. MSAF is required to obtain its next annual appraisals no later than 30 days prior to October 31, 2001.
The appraisals for the portfolio as of September 30, 2000 are set out below.
PORTFOLIO INFORMATION
THE AIRCRAFT
All of the aircraft hold or are capable of holding a noise certificate issued under Chapter 3 of Volume 1, Part II of Annex 16 of the Chicago Convention or have been shown to comply with the Stage 3 noise levels set out in Section 36.5 of Appendix C of Part 36 of the United States Federal Aviation Regulations.
The following table sets forth the exposure as of February 15, 2001 of our portfolio by type of aircraft calculated by reference to the number of aircraft and their appraised value as of September 30, 2000.
The following table sets forth the exposure as of February 15, 2001 of our portfolio to the lessees calculated by reference to the appraised value as of September 30, 2000 of the aircraft.
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(1) Total number of lessees = 42.
(2) Although this A320 was subject to a lease as of February 15, 2001, it was not delivered to the lessee until February 17, 2001.
The following table sets forth the exposure as of February 15, 2001 of our portfolio to countries in which the lessees are domiciled calculated by reference to the appraised value as of September 30, 2000 of the aircraft.
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(1) Total number of countries = 27.
(2) Although this A320 was subject to a lease as of February 15, 2001, it was not delivered to the lessee until February 17, 2001.
The following table sets forth the exposure as of February 15, 2001 of our portfolio by regions in which the lessees are domiciled calculated by reference to number of aircraft and their appraised value as of September 30, 2000.
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(1) Regions are defined according to MSCI designations.
(2) Although one A320 was subject to a lease as of February 15, 2001, it was not delivered to the lessee until February 17, 2001.
The following table sets forth the exposure as of February 15, 2001 of our portfolio by year of aircraft manufacture calculated by reference to the appraised value as of September 30, 2000 of the aircraft. The weighted average age of the fleet as of September 30, 2000 was approximately 9 years.
The following table sets forth the exposure as of February 15, 2001 of our portfolio by seat category calculated by reference to the appraised value of our aircraft as of September 30, 2000.
MSAF GROUP PORTFOLIO ANALYSIS
The following table sets forth additional information on our portfolio as of February 15, 2001 (except for appraised values, which are as of September 30, 2000).
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(1) Regions are defined according to MSCI designations.
(2) Although this A320 was subject to a lease as of February 15, 2001, it was not delivered to the lessee until February 17, 2001.
DESCRIPTION OF THE AIRCRAFT
The following table sets forth certain available information with respect to the body type, number of seats, engine manufacturer, production years, current fleet, number of aircraft on order and number of operators of each aircraft type in our portfolio as of February 15, 2001.
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Source: Airclaims Limited.
(1) The above table identifies engine manufacturers by the following abbreviations:
GE = General Electric
PW = Pratt & Whitney
CFM = CFM International
IAE = International Aero Engines
RR = Rolls Royce
TBA = To be announced.
(2) The number of operators does not include lessors.
ACQUISITION OF ADDITIONAL AIRCRAFT
MSAF may acquire additional commercial passenger or freight aircraft from various sellers. Cash flows derived from any additional aircraft and the related leases will be available to satisfy MSAF's payment obligations, including payments of interest, principal and premium, if any, on the notes and any additional notes. There is no limit on the aggregate value of additional aircraft that may be acquired or on the period in which such additional aircraft must be acquired. Any acquisition of additional aircraft and related issuance of additional notes will be subject to certain conditions under the indenture.
THE LEASES
As of February 15, 2001, we had 60 leases in effect, covering our whole portfolio except two aircraft which were off-lease. Although the lease documentation is fairly standardized in many respects, significant variations do exist as a result of negotiation with each lessee. The following is a summary of the principal characteristics of the leases as of February 15, 2001 (with appraised values as of September 30, 2000).
OPERATING LEASES
INTRODUCTION
Operating leasing has grown steadily over the last decade:
- to facilitate the matching of excess aircraft supply and demand in different geographical regions;
- to provide short-to-medium term capacity (i.e. for less than the useful life of an aircraft); and
- to bridge the financing gap for under-capitalized airlines, typically where financing is not otherwise available.
The following discussion highlights the principal features of an operating lease. All of our leases generally conform to this description.
LEASE PAYMENTS AND SECURITY
Operating leases require the lessees to pay periodic rentals during the lease term. Lessees must make payments to the lessor without set-off or counterclaim, and leases generally include an obligation of the lessee to gross-up payments under the lease where payments are subject to certain withholding and other taxes. Leases also contain an indemnification of the lessor for certain taxation liabilities (including, in some leases, value added tax and stamp duties, but generally excluding net income tax or its equivalent imposed on the lessor) and taxation of indemnity payments. Lessees are also obliged to pay default interest on any overdue amounts. In some cases, the lessee may exercise certain remedies if the lessor breaches its covenant of quiet enjoyment.
Lessees generally indemnify the lessor for operating expenses accrued or payable during the term of the lease, which normally include maintenance, operating, overhaul, airport and navigation charges, certain taxes, licenses, consents and approvals, aircraft registration and hull all risks and public liability insurance premiums. Lessees are obliged to remove liens on the aircraft other than certain liens permitted under the leases.
OPERATION OF THE AIRCRAFT
Operating leases require the lessees to operate the aircraft in compliance with all laws and regulations applicable to the aircraft. The aircraft generally must remain in the possession of the lessees, and any subleases of the aircraft generally must be approved by the lessor. Under many leases, the lessees may enter into charter or "WET LEASE" arrangements in respect of the aircraft (i.e., a lease with crew and services provided by the lessee) without the lessor's consent, provided that the lessee does not part with operational control of the aircraft. Under certain leases, the lessee is permitted to enter into subleases to specified operators without the lessor's consent, provided that certain conditions are met.
Leases generally permit lessees to subject the engines, and other equipment or components in certain cases, to removal or replacement and, in certain cases, to pooling arrangements (temporary borrowing of equipment), in some cases with permitted entities (which may include certain manufacturers, suppliers, other airlines or aircraft operators) without the lessor's consent but subject to conditions set out in the lease. Lessees may generally deliver possession of the aircraft, engines and other equipment or components to the manufacturer for testing or similar purposes, or to a third party for service, maintenance, repair or other work required or permitted under the lease. The lessor's ability to repossess the aircraft or engines, equipment or components from a sublessee, transferee, manufacturer, or other person may be restricted by liens or similar rights of detention and by applicable bankruptcy and insolvency laws.
MAINTENANCE AND MAINTENANCE RESERVES
Operating leases generally contain detailed provisions specifying maintenance standards and the required condition of the aircraft upon redelivery. In some leases, depending upon the specific maintenance condition of the aircraft or specified items (airframe, engines, certain components, auxiliary power unit or landing gear) at redelivery, the lessee may be required to make certain adjustment payments to the lessor. During the term of a lease, the lessee is required to ensure that the aircraft is maintained in accordance with an agreed maintenance program designed to ensure that the aircraft meets applicable airworthiness and other regulatory requirements in the jurisdiction in which the aircraft is registered. The agreed maintenance program is generally performed by the lessee.
In some leases, the lessee is required to provide monthly maintenance reserves, which are used to reimburse the lessee for significant maintenance charges, including major airframe and engine overhauls. In leases where there is no provision for the payment of maintenance reserves, the lessor must rely on the credit of the lessee or, if available, any credit support, and the ability of the lessee to return the aircraft in the condition required by the lease upon termination, to make any required payments based on the aircraft's return condition upon termination of the related lease and to perform scheduled maintenance throughout the lease term.
Lessees are generally required under the leases to comply with "ADS", or airworthiness directives, of the applicable aviation authorities specified in the leases and with manufacturer's service bulletins, and lessees primarily bear the cost of compliance. However, the lessor may be required by the lease to contribute to the cost of certain ADs or manufacturer's service bulletins or to the cost above a specified threshold.
INDEMNIFICATION AND INSURANCE OF AIRCRAFT
LIABILITY INSURANCE
In addition to operational indemnities under the lease, operating leases require lessees to carry insurance for any liabilities arising out of the operation of the aircraft, including liabilities for death or injury to persons and damage to property that ordinarily would attach to the operator of the aircraft. Liability insurance coverage typically includes third party legal liability, passenger legal liability, baggage legal liability, cargo legal liability, mail and aviation general third party (including products) legal liability. Liability insurance coverage is generally subject to customary industry exclusions.
In some jurisdictions liabilities for risks that lessees insure against may also attach to the owner of the aircraft whether or not the owner is in any way responsible for the related loss. In addition, claimants may assert claims against the aircraft owner on the basis of alleged responsibility for a loss. Operating leases generally require that lessees indemnify owners against third party claims, including the costs of defending against such claims. Indemnified losses include both aircraft operating costs as well as losses to persons and property resulting from the operation of the aircraft. The latter types of losses are generally covered by the lessee's liability insurance.
AIRCRAFT PROPERTY INSURANCE
Operating leases also require that lessees carry various types of aircraft property insurance that are customary in the air transportation industry. The aircraft property insurance typically includes all risks, aircraft hull and hull war risks insurance (in each case at a stipulated lease value, subject to adjustment in certain circumstances) and aircraft spares insurance (on a replacement cost basis). The lessor is permitted, in most cases, to increase the insured value above the stipulated lease value consistent with industry practice with the lessee responsible for any increase in the premium. In addition to the stipulated lease value coverage obtained by the lessee, the lessor may purchase "total loss only" coverage for certain aircraft. Aircraft property insurance is also subject to customary industry deductions.
Operating leases generally include provisions defining an event of loss or a casualty occurrence so that where a total loss of the airframe occurs, with or without loss of the engines installed on the airframe, the agreed value is payable by the lessee. This payment is generally funded with insurance proceeds. However, the industry practice is to treat only a loss of greater than 75% of the value of the aircraft, including the engines, as a total loss. In the case of a total loss of 75% or less of the value of the aircraft, the lessee is generally responsible for the payment of the difference between the insurance proceeds and the stipulated lease value. Where insurance proceeds do cover a total loss, most operating leases require that the lessor pay the balance of any insurance proceeds received under hull all risks or war risks policies to the lessee, after deducting any amounts payable by the lessee under the lease.
Insurance certificates generally contain a breach of warranty endorsement. This endorsement ensures that additional insureds continue to be protected even if the lessee violates one or more of the terms, conditions or warranties of the insurance policies, provided that the additional insured has not caused, contributed to or knowingly condoned such breach.
Operating leases may also require that lessees maintain, as part of their hull war and allied perils insurance, coverage for confiscation or requisition of the aircraft. This includes confiscation or requisition by the relevant state of registration. However, in certain countries (including France and China) such insurance may not be obtainable.
CONTINGENT LIABILITY COVERAGE
Lessors of aircraft under operating leases may obtain additional contingent liability coverage. This operates both to cover any liability in excess of the coverage provided by a lessee's policy and where a lessee's policy lapses for any reason, including an early termination of a lease and repossession of an aircraft. The amount of the contingent liability policies may not be the same as required under the relevant lease and is generally subject to certain limitations imposed by the air transportation insurance industry.
ITEM 2.
ITEM 2. PROPERTIES
MSAF group has no ownership or leasehold interest in any real property.
MSAF group's registered and principal office is located at 1100 North Market Street, Rodney Square North, Wilmington, Delaware 19890-0001 and its telephone number is 302-651-1000.
For a description of MSAF group's interest in other property, see "The Portfolio" and "Operating Leases" under Item 1.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Neither MSAF group nor any of its subsidiaries is involved in or subject to any legal or arbitration proceedings relating to claims or amounts which are material nor is MSAF group aware that any such proceedings are pending or threatened.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As of the date of this Report on Form 10-K, all of the beneficial interest in MSAF group is owned by MSAF Holdings, a wholly owned subsidiary of MSDW Aircraft Holdings, which in turn is a wholly owned subsidiary of MS Financing Inc. ("MSF"), which in turn is a wholly owned subsidiary of MSDW. No equity securities of MSAF group are listed on any national exchange or traded in any established market.
At the time of the issuance of the 1998 Notes, MSAF group paid a beneficial interest distribution of approximately $976 million to MSF.
Simultaneous with the issuance of the 2000 Notes and the acquisition of certain net assets from MSF, MSAF group received a non-cash capital contribution of $78.0 million from MSF.
For additional information regarding the corporate governance of MSAF group, see Item 10.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data in the following table have been derived from, and should be read in conjunction with, MSAF group's consolidated financial statements as of and for the fiscal years ended November 30, 2000, 1999, 1998 and for the period from October 30, 1997 (date of formation) to November 30, 1997, including the notes thereto (the "FINANCIAL STATEMENTS"). MSAF group's Financial Statements have been audited by Deloitte & Touche LLP, independent auditors.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The initial MSAF group entities were organized in late 1997 and since that time their principal business activity has been the acquisition of aircraft and the placement of such aircraft on operating lease. MSAF group's future business is expected to consist principally of aircraft operating lease activities, acquisitions of additional aircraft and sales of aircraft. Cash flows generated from such activities will be used to service interest and principal on its outstanding notes payable, any refinancing notes and any additional notes but only after various expenses of MSAF group have been paid for, including any taxes, obligations to lessees including maintenance obligations, fees and expenses of ILFC and other service providers and payments to MSAF group's interest rate swap counterparties.
MSAF group's ability to generate sufficient cash from its aircraft assets to service the outstanding notes payable depends primarily on (1) the rental rates it can achieve on leases and the lessees' ability to perform according to the terms of those leases and (2) the prices it can achieve on any aircraft sales. MSAF group's ability to service the outstanding notes payable also depends on the level of its operating expenses, including maintenance obligations which will increase as the aircraft age, and on any unforeseen contingent liabilities arising.
MSAF group's portfolio of aircraft assets consists of 61 aircraft and one engine. The aggregate appraised value of this portfolio was $1,911.2 million as of September 30, 2000. Based on the appraised values as of September 30, 2000, no one aircraft accounts for more than 5% of MSAF group's portfolio. As of February 15, 2001, MSAF group had 60 lease contracts in effect with 42 lessees based in 27 countries, and two aircraft off-lease. As of February 15, 2001, the weighted average remaining contracted lease term of the portfolio (weighted by appraised values as of September 30, 2000 and without giving effect to existing non-binding letters of intent, purchase options or extension options) was 34.1 months. The longest lease is scheduled to expire in September 2013. Therefore, MSAF group will be required to re-lease each of the aircraft one or more times prior to the final maturity date for its notes.
RECENT DEVELOPMENTS
LESSEE DIFFICULTIES
As of February 15, 2001, seven current lessees were in arrears. The total amount outstanding and overdue for the seven lessees in respect of rental payments and maintenance reserves due under the leases amounted to $6.9 million. MSAF group held security deposits of $5.3 million against these arrears. The weighted average number of days past due of such arrears was 65 days.
REGIONAL ANALYSIS OF EXISTING ARREARS
The categorization of countries into geographical regions, Developed Markets, Emerging Markets and Other is determined using Morgan Stanley Capital International, Inc. ("MSCI") designations.
EUROPE AND MIDDLE EAST (EMERGING)
Three of the seven current lessees in arrears as of February 15, 2001, are based in the Europe and Middle East (Emerging) region.
As of February 15, 2001, one of the lessees, Air Alfa, owed rental and maintenance arrears of $2.7 million against which MSAF group held a security deposit of $0.7 million. The lessee is unable to cure its payment defaults and as a result in February 2001, ILFC commenced repossession proceedings.
As of February 15, 2001, a second lessee, Travel Service, owed rental arrears of $0.03 million, against which MSAF group held a security deposit of $0.5 million.
As of February 15, 2001, a third lessee, Olympic, owed maintenance arrears of $0.1 million, against which MSAF group held a security deposit of $0.5 million.
EUROPE (DEVELOPED)
One of the seven current lessees in arrears as of February 15, 2001, Air Europa, is based in the Europe (Developed) region. As of February 15, 2001, Air Europa owed rental and maintenance arrears of $0.4 million against which MSAF group held a security deposit of $0.5 million.
In January 2000, TransAer, a lessee based in Ireland, restructured rental and maintenance arrears for two A320-200 aircraft into a note payable of $1.4 million. The terms of the restructuring agreement were that amounts totaling $1.4 million would be repaid during June, July and August 2000. None of these restructured arrears were paid. On October 20, 2000, TransAer filed for bankruptcy, with total arrears outstanding of $1.6 million at that date. MSAF group drew down security deposits of $1.0 million against these arrears.
The lease with respect to one of the A320-200 aircraft with TransAer was terminated in October 2000. TransAer had been operating this aircraft on wet lease to Libyan Arab Airlines, which has detained the aircraft. MSAF group believes that Libyan Arab Airlines has no right to keep possession of the aircraft. ILFC has submitted an insurance claim for the loss of the aircraft, which is currently pending. ILFC also continues to explore recovery options consistent with compliance with U.S. law. MSAF group may incur significant costs and time in resolving this matter.
The second A320-200 aircraft was delivered to a new lessee based in Cyprus on February 17, 2001.
ASIA (EMERGING)
As of February 15, 2001, none of the lessees in this region were in arrears.
LATIN AMERICA (EMERGING)
As of February 15, 2001, none of the current lessees in this region were in arrears. Three aircraft repossessed during fiscal 2000 had been on lease to lessees based in Latin America, two in Brazil, and one in Mexico.
A former Brazilian lessee, B.R.A., which had been operating one A310-300 subject to a capital lease, defaulted on its obligations under its lease and the aircraft was repossessed in April 2000. The lease had been scheduled to expire in July 2007. The total amount of rental payments in arrears at the date of the repossession was $1.3 million. There was no security deposit held by MSAF group to offset against the arrears balance. The aircraft was delivered to a new lessee based in the Pacific region on December 18, 2000.
A second former Brazilian lessee, VASP, defaulted on its obligations under its lease of a B737-300 aircraft and the aircraft was repossessed in May 2000, following legal proceedings against VASP. The aircraft could not be re-leased until it had been deregistered from the Brazilian aircraft registry.
Deregistration was completed on February 22, 2001 following protracted legal proceedings against VASP. ILFC is currently remarketing the aircraft. The lease had been scheduled to expire in March 2003. The total amount of rental payments due under the lease at the date of the repossession was $0.5 million against which MSAF group drew down a security deposit of $0.7 million.
A former Mexican lessee, TAESA, defaulted on its obligations under its lease of a B737-400 aircraft, and the aircraft was repossessed in December 1999. The lease was scheduled to expire in May 2001. The total amount of rental payments and maintenance reserves due under the lease at the date of repossession was $0.6 million. This amount was partially offset by a security deposit of $0.5 million. On February 21, 2000, a court in Mexico declared TAESA bankrupt. It is uncertain whether MSAF group will be able to recover the $0.1 million outstanding from TAESA. This aircraft is currently on lease to Travel Service, a carrier based in the Czech Republic.
In July 1999, a former Brazilian lessee, VARIG, negotiated early termination of a B747-300 lease that was scheduled to expire in April 2003. The total amount of rental payments and maintenance reserves due under this lease through July 1999, the date of the termination agreement, was $4.8 million, against which MSAF group drew down a security deposit of $1.1 million. Under the terms of the termination agreement, VARIG has agreed to repay arrears of $4.8 million and approximately $6.0 million for certain maintenance and downtime costs over the next eight years. Payments to MSAF group will be made semi-annually beginning on October 15, 1999 with final payment due on October 15, 2007. As of February 15, 2001 VARIG had made all payments due under the restructuring agreement. MSAF group is recognizing this income on a cash basis as received.
NORTH AMERICA (DEVELOPED)
Two of the seven current lessees in arrears as of February 15, 2001, are based in the North America (Developed) region.
On December 6, 2000, National announced that it had voluntarily filed petitions in the U.S. District Court in Wilmington, Delaware for relief under Chapter 11 of the U.S. Bankruptcy Code. MSAF group has one aircraft, a B757-200ER on lease to National. As of February 15, 2001, rental arrears were $1.1 million against which MSAF group held a security deposit of $0.6 million. It is not yet clear whether National will raise the necessary financing to continue operations.
On January 10, 2001, TWA announced that it and certain of its subsidiaries had voluntarily filed petitions in the U.S. District Court in Wilmington, Delaware for relief under Chapter 11 of the U.S. Bankruptcy Code. TWA also announced that it had reached agreement with American Airlines in which American Airlines would acquire substantially all the assets of TWA. This agreement is subject to certain regulatory approvals, including that of the bankruptcy court. MSAF group has four aircraft on lease to TWA, a B757-200ER, two MD-83's and one MD-82. At February 15, 2001, rental arrears were $1.3 million against which MSAF group held security deposits of $2.0 million. MSAF group does not yet know whether TWA intends to affirm or reject some or all of these leases in its bankruptcy proceeding or how the agreement between American Airlines and TWA may impact these leases.
PACIFIC (DEVELOPED)
As of February 15, 2001 none of the lessees in this region were in arrears.
OTHER
One of the seven current lessees in arrears as of February 15, 2001, is based in the Other region. As of February 15, 2001, rental and maintenance arrears owed by Air Atlanta Icelandic were $1.3 million, against which MSAF group held a security deposit of $0.5 million.
AIRWORTHINESS DIRECTIVE
On September 14, 2000 the United States Federal Aviation Administration ("FAA") announced a proposal for the long-term redesign of the Boeing 737 rudder system and several short-term initiatives designed to enhance rudder safety on all Boeing 737 models. It may be some time before the FAA issues a formal Airworthiness Directive ("AD"). There are currently twenty B737 aircraft in MSAF group's portfolio. One of these B737 aircraft is currently off-lease, but under the remaining nineteen leases all costs of compliance with ADs are the obligation of the lessees.
The FAA issued two ADs (one in July and one in August 2000) requiring special detailed inspections to detect cracking of the main deck cargo door frames of Pemco-converted Boeing 737-200 and 737-300 freighters. The FAA is now considering a further AD to supersede the first two, the result of which may be a requirement to replace the main deck cargo door frames. There are two aircraft in MSAF group's portfolio which may be subject to the findings of the FAA. Under the lease of the first aircraft, all costs of compliance with ADs are the obligation of the lessee. Under the lease of the second aircraft, the costs of compliance with this possible future AD are to be shared by MSAF group and the lessee. The lessee of the second aircraft has completed all required changes in respect of this possible future AD at a cost of less than $0.05 million.
RESULTS OF OPERATIONS--YEAR ENDED NOVEMBER 30, 2000
MSAF group's results of operations for the year ended November 30, 2000 ("FISCAL 2000") are not directly comparable to those of the year ended November 30, 1999 ("FISCAL 1999") due to MSAF group's acquisition of a portfolio of 29 commercial aircraft from MSF on March 15, 2000.
NET (LOSS)/INCOME
MSAF group incurred a net loss of $8.1 million in fiscal 2000 as compared to a net loss of $7.9 million in fiscal 1999. The decrease in net income primarily reflects a higher level of expenses partially offset by an increase in lease income.
MSAF is a Delaware business trust treated as a branch of MSF for U.S. Federal, state and local income tax purposes. Accordingly, MSAF is not subject to U.S. Federal, state and local income taxes.
LEASE INCOME
Lease income for fiscal 2000 amounted to $219.8 million as compared to $114.7 million in fiscal 1999. The increase in lease income is primarily due to MSAF group's acquisition of 29 commercial aircraft, coupled with a release of excess maintenance reserves associated with certain of MSAF group's former lessees, partially offset by a reduction in lease revenue associated with aircraft on ground.
MSAF group's operating results for fiscal 2000 included provisions for doubtful accounts totaling $1.5 million. Such provisions were recorded by MSAF group due to financial difficulties experienced by certain of MSAF group's current lessees, as well as to reserve against amounts owed to MSAF group by certain of its former lessees whose aircraft have already been repossessed (see "--Lessee Difficulties"). Provisions for doubtful accounts were $6.4 million in fiscal 1999. Lease income may decline in future periods due to potential lessee defaults and arrears including those discussed above.
MSAF group records the cash prepayments made by lessees for maintenance as a component of the liability for maintenance account which appears on the Consolidated Balance Sheets. When the lessee incurs maintenance expenditures, MSAF group must return a corresponding amount of the prepayment to the lessee. At this time, MSAF group will forward cash to the lessee, with a corresponding decrease to the liability for maintenance account. MSAF group will only reimburse the lessee for the cost of maintenance expenditures to the extent that sufficient prepayments have been made by the lessee. At the time an aircraft is re-leased to a new lessee, an assessment is made of the expected maintenance reserve
requirements; any excess reserve is then released to lease income. MSAF group released $25.6 million of excess maintenance reserves to lease income in fiscal 2000 as compared to $1.6 million in fiscal 1999.
INVESTMENT INCOME
Investment income for fiscal 2000 amounted to $3.7 million as compared to $1.8 million in fiscal 1999. Investment income represents interest income on MSAF group's cash and cash equivalents. Investment income has increased due to a higher level of cash and cash equivalents in connection with MSAF group's acquisition of 29 commercial aircraft. Such cash balances primarily consist of security deposits and advance rental payments made by certain lessees.
INTEREST EXPENSE
Interest expense, including swap costs of $0.3 million, amounted to $112.2 million in fiscal 2000. Interest expense, including swap costs of $5.3 million, amounted to $63.6 million in fiscal 1999. Interest expense primarily consists of interest paid on the 1998 Notes and the 2000 Notes. The increase in interest expense is primarily due to the 2000 Notes, which were issued on March 15, 2000, coupled with a higher average interest rate on the 1998 Notes. The weighted average interest rate on MSAF group's notes payable during fiscal 2000 was 6.98% as compared to 6.03% during fiscal 1999, reflecting a higher interest rate environment. The average principal balance in respect of MSAF group's notes payable during fiscal 2000 was $1,628.7 million as compared to $956.0 million during fiscal 1999.
MSAF group is a party to twelve interest rate swaps with Morgan Stanley Capital Services Inc. ("MSCS"), a wholly owned subsidiary of MSDW. In ten of these swaps, MSAF group paid a fixed monthly coupon and received one month LIBOR on a notional balance of $1,300 million and in two of these swaps, MSAF group paid one month LIBOR and received a fixed monthly coupon on a notional balance of $200 million.
MSAF group was a party to one additional interest rate swap with MSCS with a notional balance of $300 million that matured on November 15, 2000. In that swap MSAF group paid a fixed monthly coupon and received one month LIBOR.
Eight of the swaps, having an aggregate notional principal amount of $1,100 million, are accounted for as hedges of the notes. Under these swap arrangements, MSAF group pays fixed and receives floating amounts on a monthly basis. The fair value of the liability assumed relating to those swaps which are being accounted for as hedges is deferred and recognized when the offsetting gain or loss is recognized on the hedged transaction. This amount and the differential payable or receivable on such interest rate swap contracts, to the extent such swaps are deemed to be effective hedges for accounting purposes, are recognized as an adjustment to interest expense.
The remaining four swaps have an aggregate gross notional principal amount of $400 million. Under these swap arrangements, MSAF group pays/receives fixed and receives/pays floating amounts on a monthly basis. MSAF group has determined that these swaps do not qualify for hedge accounting. The fair value of the liability assumed related to these swaps is accounted for on a mark-to-market basis with changes in fair value reflected in interest expense.
See Item 7A
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE SENSITIVITY
MSAF group's principal market risk exposure is to changes in interest rates. This exposure arises from its notes payable and the derivative instruments used to manage interest rate risk.
The terms of each subclass of the 1998 Notes and the 2000 Notes, including the outstanding principal amount and estimated fair value as of November 30, 2000 were as follows:
INTEREST RATE RISK MANAGEMENT
MSAF group's policy is not to be adversely exposed to material movements in interest rates. MSAF group's leasing revenues are generated primarily from rental payments, which are currently entirely fixed but may be either fixed or floating with respect to future leases. In general, an interest rate exposure arises to the extent that MSAF group's interest obligations in respect of its notes payable do not correlate with rental payments for different rental periods, including rental payments attributable to existing and future leases. Future leases are relevant because the duration of MSAF group's obligations under its floating rate notes is significantly longer than the duration of lease income under its fixed rate leases. MSAF group currently manages this exposure by entering into interest rate swaps. In the future MSAF group may also use other derivative instruments. Currently, MSAF group's aim is to manage the exposure created by its floating interest rate obligations given that future lease rates on new leases may not be repriced at levels which fully reflect changes in market interest rates in the previous lease period. Accordingly, MSAF group's current interest rate swap portfolio tries to minimize the risk created by its longer-term floating interest rate obligations and measures that risk by reference to the duration of those obligations and the expected sensitivity of future lease rates to future market interest rates.
The controlling trustees are responsible for reviewing and approving the overall interest rate management policies and transaction authority limits. MSAF group's financial advisor, Morgan Stanley & Co. Incorporated, assists MSAF group in developing and implementing its interest rate risk management policies.
CURRENT SWAP PORTFOLIO
As of November 30, 2000, MSAF group was a party to twelve interest rate swaps with MSCS. In ten of these swaps MSAF group paid a fixed monthly coupon and received one month LIBOR and in two of these swaps MSAF group paid one month LIBOR and received a fixed monthly coupon on the notional balances as set out below:
During fiscal 2000, MSAF group was a party to one additional interest rate swap with MSCS with a notional balance of $300 million that matured on November 15, 2000. In that swap MSAF group paid a fixed monthly coupon and received one month LIBOR.
POLICY REVIEW
MSAF group regularly reviews its hedging requirements. In the future MSAF group expects to seek to enter into further swaps or unwind part or all of the existing and any future swaps. In addition, if MSAF group acquires additional aircraft, it will need to rebalance its position.
COUNTERPARTIES
MSAF group will monitor counterparty risk on an ongoing basis. Counterparties will be subject to the prior approval of the controlling trustees. MSAF group's counterparties are currently all affiliates of MSDW. Future counterparties may consist of the affiliates of major U.S. and European financial institutions (including special-purpose derivative vehicles) which have credit ratings, or which provide collateralization arrangements, consistent with maintaining the ratings of MSAF group's notes payable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this report. See "Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K."
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
CONTROLLING AND INDEPENDENT TRUSTEES
The controlling trustees and independent trustees of MSAF, their respective ages and principal activities are as follows:
KARL ESSIG is a Managing Director and the co-head of the Global Securitized Products Group at MSDW. Mr. Essig joined MSDW in August of 1980 and has worked in the London, New York and Tokyo offices on corporate finance, capital markets, derivatives and securitization transactions. In 1986 he founded Morgan Stanley's Asset-Backed Finance Group which he headed for five years. In 1992, Mr. Essig established the International Securitisation Group, focusing on transactions in Europe and Asia, and during 1999 was appointed co-head of the worldwide business. Mr. Essig is a graduate of Stanford University and the Yale School of Management.
ALEXANDER C. FRANK is a Managing Director in the Corporate Treasury Department, and the Treasurer of MSDW. Mr. Frank joined MSDW in 1985 and has worked in the New York and London offices, in the firm's Corporate Treasury and Corporate Tax Departments. In 1990 he established Morgan Stanley Treasury's European Capital and Financing activity in London. In 1993 Mr. Frank assumed responsibility for the firm's Global Capital and Finance function and became the Treasurer for North and South American activities. In 1998, Mr. Frank was appointed Treasurer of MSDW. Mr. Frank is a graduate of Dartmouth College and the University of Michigan School of Business Administration.
A. MAURICE MASON is a Managing Director in the Aircraft Group at Morgan Stanley & Co. International Limited. He joined MSDW's Investment Banking Division in 1994 where he was responsible for MSDW's corporate finance activities in the European transportation sector. Prior to joining MSDW, he spent over six years in the capital markets group at GPA Group plc. Mr. Mason received a BA, BAI degree from Trinity College, Dublin.
C. SCOTT PETERSON is a Managing Director in the Aircraft Group at Morgan Stanley & Co. International Limited. Mr. Peterson joined MSDW in 1988 in the Fixed Income Division. In 1989 he established the Equipment Finance Group to focus on transactions backed by aircraft and other capital equipment and led both the Equipment Finance and Liability Management Groups until his transfer to London in 1996. Mr. Peterson is a graduate of Oregon State University and The Wharton School.
JUAN C. O'CALLAHAN is principal of JOCR, an aviation consultancy based in Connecticut. He joined The Boeing Company in 1961 after a career as a fighter pilot with the United States Marine Corps and has since worked at Pacific Air Lines, World Airways and GPA Group plc (having founded TAI, a forecasting and valuation consultancy that was acquired by GPA in 1982). He has served on the boards of America West Inc., Avitas Inc., Pembroke Capital Limited and WorldCorp Inc. Mr. O'Callahan is a graduate of the University of Pittsburgh, where he obtained a BSc in Aeronautical Engineering.
ALEXANDER C. BANCROFT is a partner of the law firm of Shearman & Sterling. He specializes in the legal aspects of the financing of aircraft and other transportation equipment. He joined Shearman & Sterling in
1964 after military service and became a partner in 1973. Mr. Bancroft is a graduate of Harvard College and Harvard Law School.
The independent trustees are entitled to participate in all meetings of the controlling trustees but are only entitled to vote on any action (1) to cause MSAF or any subsidiary of MSAF to institute any proceeding seeking liquidation or insolvency or similar proceeding, (2) to consent to any liquidation, insolvency or similar proceeding instituted against MSAF or any subsidiary of MSAF, (3) to take certain other actions related to insolvency matters, and (4) to sell, transfer, or otherwise dispose of, directly or indirectly, any aircraft where the proceeds received from such sale or transfer are less than certain targets set forth in the indenture. The unanimous consent of all the controlling trustees and the independent trustees shall be required to take any action specified in clauses (1), (2) or (3) above.
As is common with many other special purpose companies, MSAF does not have any employees or executive officers. Accordingly, the controlling trustees rely upon ILFC and the other service providers, including affiliates of MSDW, for all asset servicing, executive and administrative functions pursuant to the respective service provider agreements. See "Business--Risk Factors--No Executive Management--Reliance on Third Parties to Manage Our Business" under Item 1. Certain individuals other than the controlling trustees and the independent trustees listed above may serve as controlling or independent trustees or directors of various subsidiaries of MSAF group where provisions of local law mandate a particular citizenship for trustees or directors.
THE SERVICER
ILFC AND ITS AFFILIATES CANNOT BE HELD RESPONSIBLE FOR ANY LIABILITIES OF MSAF OR ITS AFFILIATES, INCLUDING ANY PAYMENTS DUE TO NOTEHOLDERS ON THE NOTES.
ILFC is engaged in the leasing and management of commercial jet aircraft under operating leases for its own portfolio as well as for third party lessors. As of December 31, 2000, the portfolio of aircraft managed by ILFC comprised 494 aircraft, of which ILFC and its affiliates owned 402, valued at greater than $20 billion. ILFC has commitments and options to purchase a total of 539 aircraft from manufacturers, deliverable through 2009. In addition, ILFC is engaged in the remarketing of commercial jets for its own account, for airlines and for third party lessors.
ILFC is headquartered in Los Angeles, California, from where its staff of approximately 104 employees handles all of the leasing, management and remarketing relationships. ILFC's management services include collecting rental payments, arranging and monitoring aircraft maintenance performed by others, technical inspection of aircraft, arranging and monitoring insurance, arranging for aircraft valuations, registration and deregistration of aircraft, monitoring compliance with lease agreements and enforcement of lease provisions against lessees and facilitating delivery and redelivery of aircraft. ILFC may also arrange the sale of its customers' aircraft to third parties.
ILFC provides services with respect to all of the aircraft in our portfolio (except where a substitute servicer may perform the services as described below) under an amended and restated servicing agreement which, among other things, provides that ILFC will act in accordance with applicable law and with directions given by MSAF group from time to time in accordance with the servicing agreement. In addition ILFC agrees to perform its services in accordance with the ILFC Services Standard and the ILFC Conflicts Standard, as described below.
Pursuant to the servicing agreement, ILFC will not be liable to MSAF group for any losses arising (1) as a result of an aircraft or engine sold, leased or purchased on less favorable terms than might have been achieved at any time, provided such transactions were entered into on the basis of a commercial decision of ILFC or (2) in respect of ILFC's obligation to apply the ILFC Conflicts Standard in respect of its performance of the services, except, in either situation, in the case of wilful misconduct or fraud on the part of ILFC.
AIRCRAFT SERVICES
ILFC has agreed to:
- engage and maintain the necessary staff and supporting resources required to perform its services;
- grant MSAF group and its agent, access to its information, programs, records and personnel to enable MSAF group to monitor its compliance with the servicing agreement and for general MSAF group business; and
- separate its own funds from the funds of any person within MSAF group.
ILFC provides a wide range of services to MSAF group, including:
- lease marketing, such as remarketing, lease drafting, negotiation and execution;
- aircraft asset management, such as rent collection, aircraft maintenance, insurance, contract compliance and enforcement against current lessees, and accepting delivery and redelivery of aircraft;
- current aircraft sales;
- arranging valuations and monitoring and advising MSAF group on regulatory developments;
- assisting MSAF group to stay in compliance with certain covenants under the indenture;
- providing MSAF group with data and information relating to our aircraft and the commercial aviation industry;
- assistance with any public or private offering and sale of refinancing notes or additional notes of MSAF;
- legal and other professional services relating to the lease, sale or financing of our aircraft, amendment modification or enforcement of our aircraft lease; and
- periodic reporting of operational, financial and other information on our aircraft and leases.
OPERATING GUIDELINES
ILFC does not have any fiduciary or other implied duties to the noteholders or MSAF group, and its obligations are limited to the express terms of the servicing agreement. In accordance with the express terms of the servicing agreement, ILFC will act in accordance with applicable law and with MSAF group's directions.
ILFC may exercise such authority as is necessary to give it a practicable and working autonomy in performing the services and must also comply with the following two principal contractual standards in performing its services.
(1) ILFC must perform its services with reasonable care and diligence as if it were the owner of the aircraft consistent with the customary commercial practice of a prudent international aircraft lessor in the management servicing and marketing of commercial jet aircraft and related assets. This is referred to as the "ILFC SERVICES STANDARD".
(2) If a conflict of interest arises regarding ILFC's management, servicing or marketing of: (a) any two aircraft in our portfolio or (b) any aircraft in our portfolio and any other assets owned, managed, serviced or marketed by ILFC, ILFC is required to notify MSAF and perform the services in good faith. If the two aircraft and other assets owned, managed, serviced or marketed by ILFC are substantially similar in terms of objectively identifiable characteristics that are relevant for the particular services to be performed, ILFC will not discriminate among the aircraft or between any of
the aircraft in our portfolio and any other aircraft then owned, managed, serviced or marketed by ILFC on an unreasonable basis. This is referred to as the "ILFC CONFLICTS STANDARD".
All transactions to be entered into by ILFC on behalf of MSAF group (other than with other persons within MSAF group) must be at arm's length and on fair market value terms unless otherwise agreed or directed by MSAF group. Certain transactions or matters require the specific approval of MSAF group, including:
- sales of (or commitments or agreements to sell) aircraft, other than as required by a lease;
- the entering into of any new leases (including renewals or extensions, unless any such lease had originally been approved) if the lease does not comply with any applicable operating covenants set forth in the indenture.
- terminating any lease or leases to any single lessee with respect to aircraft then having a value in excess of $100 million;
- unless provided for in the applicable budget, entering into any contract for the modification or maintenance of aircraft where the costs to be incurred (A) exceed the greater of (i) the estimated aggregate cost of a heavy maintenance or structural check for similar aircraft and (ii) available maintenance reserves or other collateral under the related lease or (B) are outside the ordinary course of MSAF group's business;
- entering into any capital commitment or confirming any order or commitment to acquire or acquiring aircraft or engines on behalf of MSAF group, except, with respect to a replacement engine or a spare part for an aircraft, (A) if provided for in the applicable budget or (B) at such times and on such terms and conditions as ILFC deems reasonably necessary or appropriate and in no greater quantity than that which is required to enable the aircraft to be leased;
- issuing any guarantee on behalf of, or otherwise pledging the credit for borrowed money of, any person within MSAF group;
- unless otherwise permitted, entering into any agreement for services to be provided in respect of aircraft by third parties at MSAF group's cost outside the ordinary course of ILFC's business, except to the extent provided for in the applicable budget; and
- incurring or causing to be incurred on behalf of any person within MSAF group any liability (actual or contingent), unless contemplated in the applicable budget, pursuant to a transaction of a type for which MSAF group's specific approval is otherwise required, or incurred in the ordinary course of MSAF group's business.
BUDGETS
MSAF group will adopt an annual and a three-year budget each year for all aircraft. ILFC has agreed to use its best efforts to achieve the annual budget for each year.
MANAGEMENT FEES AND SERVICER EXPENSES
ILFC receives the following fees:
- a monthly retainer fee equal to approximately $250,000;
- a monthly fee equal to 1% of the aggregate rent due for any month (or portion of a month); and
- a monthly fee equal to approximately 1.25% of the aggregate rent actually paid for the month.
In addition, ILFC receives certain incentive fees based on MSAF group results and aircraft sales. For the fiscal year ended November 30, 1998 ILFC received $0.5 million in result-based incentive fees. For the
fiscal years ended November 30, 1999 and November 30, 2000, no result-based incentive fees were paid to ILFC. There were no sales-based incentive fees for any of the above periods.
ILFC also will be reimbursed for certain expenses incurred in connection with its performance of the services.
TERM AND TERMINATION
For the 32 aircraft and one engine that we acquired in 1997 and 1998, the servicing agreement will expire on May 26, 2023. For the 29 aircraft that we acquired in 2000, the servicing agreement will expire on May 1, 2025.
ILFC may terminate the servicing agreement if:
- MSAF does not pay any amount payable by MSAF within five days of a delinquency notice;
- MSAF or any of its subsidiaries shall materially breach any of their obligations under the servicing agreement other than payment obligations;
- all of the public debt of the MSAF group is repaid or defeased in full in accordance with the terms of any indenture;
- all of the aircraft in our portfolio are sold;
- an involuntary proceeding under applicable bankruptcy, insolvency, receivership or similar law against MSAF, any of its subsidiaries or a substantial part of the property or assets of any person within MSAF group, continues undismissed for 120 days or any such person shall go into liquidation, suffer a receiver or mortgagee to take possession of all or substantially all of its assets or have an examiner appointed over it, or a petition or proceeding is presented for any of the foregoing and not discharged within 120 days; or
- a voluntary proceeding is commenced under bankruptcy, insolvency, receivership or similar law by MSAF or any of its subsidiaries or MSAF or any of its subsidiaries, consents to the institution of, or fails within 120 days to contest the filing of, any petition described above, or files an answer admitting the material allegations of any such petition, or makes a general assignment for the benefit of its creditors.
MSAF may terminate the servicing agreement if:
- ILFC materially breaches any of its obligations under the servicing agreement;
- ILFC fails, within a reasonable period of time, to re-lease an aircraft upon the termination of any lease or to sell an aircraft upon commercially reasonable written direction from MSAF;
- all of the public debt of the MSAF group is repaid or defeased in full in accordance with the terms of any indenture;
- all of the aircraft in MSAF group's portfolio are sold;
- a rating decline occurs as a result of a change of control of ILFC;
- an involuntary proceeding under applicable bankruptcy, insolvency, receivership or similar law against ILFC or any of its subsidiaries continues undismissed for 120 days or ILFC goes into liquidation, suffers a receiver or mortgagee to take possession of all or substantially all of its assets or has an examiner appointed over it or if a petition or proceeding is presented for any of the foregoing and not discharged within 120 days; or
- a voluntary proceeding is commenced by ILFC under bankruptcy, insolvency, receivership or similar law or ILFC consents to the institution of, or fails within 120 days to contest the filing of, any petition described above, or files an answer admitting the material allegations of any such petition, or ILFC makes a general assignment for the benefit of its creditors.
Except where ILFC terminates the servicing agreement because MSAF does not pay ILFC, the servicing agreement may not be terminated unless a replacement servicer has been appointed and accepts such appointment. In the event that a replacement servicer has not been appointed within 90 days after any termination of the servicing agreement or resignation by ILFC, ILFC may petition any court of competent jurisdiction for the appointment of a replacement servicer.
ASSIGNMENT OF SERVICING AGREEMENT
ILFC and MSAF may not assign their rights and obligations under the servicing agreement without each other's prior consent.
PRIORITY OF PAYMENT OF SERVICING FEES AND REIMBURSABLE EXPENDITURES
ILFC's fees and expenses rank senior in priority of payment to all payments on the notes.
CORPORATE MANAGEMENT
ADMINISTRATIVE AGENT
Cabot Aircraft Services Limited acts as the administrative agent of MSAF group. Cabot is an indirect wholly owned subsidiary of MSDW.
Cabot is responsible for providing administrative, accounting, bank account management and calculation and other services to MSAF. Cabot's duties include:
- monitoring the performance of ILFC (including ILFC's compliance with the servicing agreement) and reporting on such performance to MSAF;
- preparing annual budgets and presenting them to MSAF group for approval;
- preparing and coordinating reports to investors and to the Securities and Exchange Commission, including preparing press releases and managing investor relations with the assistance of outside counsel and auditors, if appropriate;
- providing the trustee with information required by the trustee to provide its reports to the noteholders; and
- providing additional services upon the request of MSAF group upon terms to be agreed at the time of any such request.
Cabot may delegate one or more of the above administrative services to a third party.
Cabot receives a monthly fee equal to 0.5% of the rental payments made by the lessees under the leases for such month from MSAF group in respect of its services to MSAF group subject to an annual minimum of $500,000. Cabot is entitled to indemnification by MSAF group for, and will be held harmless against, any loss or liability incurred by Cabot arising out of or in connection with its provision of administrative services to MSAF group (other than through its own deceit, fraud, gross negligence or wilful misconduct or that of its officers, directors, agents and employees). MSAF group may remove Cabot at any time on 120 days' written notice. Cabot may resign on 120 days' written notice in certain circumstances.
CASH MANAGER
Bankers Trust Company acts as the cash manager. Subject to certain limitations and at the direction of MSAF group, Bankers Trust is authorized to invest the funds held by MSAF group in the accounts in certain prescribed investments (the "PERMITTED ACCOUNT INVESTMENTS") on permitted terms.
Bankers Trust devotes the same amount of time and attention to and is required to exercise the same level of skill, care and diligence in the performance of its services as a prudent business person would in administering such services on its own behalf. Bankers Trust's annual fees are not expected to exceed
$50,000 per annum. Bankers Trust is entitled to indemnification by MSAF group for, and will be held harmless against, any loss or liability incurred by Bankers Trust (other than through its own gross negligence (or simple negligence in the handling of funds), deceit, fraud or wilful misconduct or that of its officers, directors, agents and employees).
MSAF may remove Bankers Trust at any time on 90 days' written notice as long as MSAF group has engaged another person or entity to perform the services that were being provided by Bankers Trust. Bankers Trust may resign on 90 days' written notice as long as MSAF group has engaged another person or entity to perform the services that were being provided by Bankers Trust.
FINANCIAL ADVISOR
Morgan Stanley & Co. Incorporated acts as the financial advisor. Morgan Stanley & Co. Incorporated is a wholly owned subsidiary of MSDW.
The financial advisor is responsible for assisting MSAF group in developing and implementing its interest rate risk management policies and developing models for the purposes of analyzing the financial impact of aircraft lease, sale and capital investment decisions. The financial advisor receives a fee of $50,000 per annum, payable monthly in arrears in equal installments, from MSAF group in respect of its services to MSAF group. MSAF or the financial advisor may terminate the financial advisory agreement on 30 days' written notice.
DELAWARE TRUSTEE
Wilmington Trust Company acts as agent for service of process in Delaware and signs certain filings with the Delaware Secretary of State on behalf of MSAF group, other than Aircraft SPC-5, Inc. and the leasing subsidiaries. Wilmington Trust maintains MSAF group's principal place of business in Delaware.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
All trustees are compensated for travel and other expenses incurred by them in the performance of their duties. MSAF group pays each independent trustee $50,000 per annum for their services in such capacity. The controlling trustees appointed by MSF as the depositor of MSAF group do not receive remuneration from MSAF group for their services.
The controlling trustees have not received any additional cash or non-cash compensation as salary or bonus for their services as controlling trustees. In the future, however, controlling trustees may receive an interest in the beneficial interest in MSAF. None of the trustees of MSAF group currently has an employment contract with MSAF group.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Not applicable.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
MSAF group has had and currently maintains various relationships with MSDW. First, MSDW acted as a promoter in establishing the entities that comprise MSAF group. Second, in fiscal 1998 MSAF group received approximately $920 million in non-interest bearing loans from MSF, a wholly owned subsidiary of MSDW, which were utilized to purchase 31 aircraft and an engine. Third, MSF held all of the beneficial interest in MSAF group and at the time of the issuance of the 1998 Notes in fiscal 1998, MSF received a beneficial interest distribution of approximately $976 million. Fourth, in fiscal 2000 MSAF group issued the 2000 Notes and received a non-cash capital contribution of approximately $78 million from MSF, which were utilized to purchase a portfolio of 29 commercial aircraft, as well as certain other assets and liabilities related to these aircraft, from MSF. Fifth, on March 15, 2000, MSF transferred the beneficial interest in MSAF group to MSDWAH, a wholly owned subsidiary of MSF. Sixth, on October 12, 2000, MSDWAH
transferred the beneficial interest in MSAF group to MSAF Holdings, a wholly owned subsidiary of MSDWAH. Seventh, Cabot, an indirect wholly owned subsidiary of MSDW, acts as the Administrative Agent for MSAF group. Eighth, the controlling trustees of MSAF group are four individuals appointed by MSF. Ninth, Morgan Stanley & Co. Incorporated is acting as financial advisor to MSAF group.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) and (2). Financial Statements: the response to this portion of Item 14 is submitted as a separate section of this report beginning on page.
(a)(3) and (c). Exhibits:
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* Previously filed on Registration Statement on Form S-4 (File No. 333-56575) with the Securities and Exchange Commission.
** Previously filed on Registration Statement on Form S-1 (File No. 333-56575) with the Securities and Exchange Commission.
*** Filed herewith
(b). Reports on Form 8-K: filed for event dates September 13, 2000, October 13, 2000, November 14, 2000 and November 22, 2000 (each relating to the monthly report to holders of the notes), October 31, 2000 (relating to the annual appraisal of the aircraft) and October 31, 2000 (relating to revision of information in Report on Form 8-K dated March 16, 2000).
(d). Not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on February 28, 2001.
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS'
To the Trustees of Morgan Stanley Aircraft Finance and Subsidiaries
We have audited the accompanying consolidated balance sheets of Morgan Stanley Aircraft Finance and Subsidiaries (the "group") as of November 30, 2000 and 1999, and the related consolidated statements of operations, cash flows and changes in beneficial interestholder's equity / (deficit) for the fiscal years ended November 30, 2000, 1999, and 1998. These consolidated financial statements are the responsibility of the group's trustees. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the trustees, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of the group at November 30, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the fiscal years ended November 30, 2000, 1999, and 1998, in conformity with accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
New York, New York January 12, 2001
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
See Notes to Consolidated Financial Statements
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
See Notes to Consolidated Financial Statements
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
See Notes to Consolidated Financial Statements
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN BENEFICIAL INTERESTHOLDER'S EQUITY / (DEFICIT)
(DOLLARS IN THOUSANDS)
See Notes to Consolidated Financial Statements
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
Morgan Stanley Aircraft Finance ("MSAF") is a special-purpose statutory business trust that was formed on October 30, 1997 under the laws of Delaware. MSAF and its subsidiaries ("MSAF group") were formed to conduct certain limited activities, including acquiring, financing, re-financing, owning, leasing, re-leasing, selling, maintaining and modifying commercial aircraft. All of the beneficial interest of MSAF group is owned by MSAF Holdings, a wholly owned subsidiary of MSDW Aircraft Holdings ("MSDWAH"), which in turn is a wholly-owned subsidiary of MS Financing Inc. ("MSF"), which in turn is a wholly-owned subsidiary of Morgan Stanley Dean Witter & Co. ("MSDW"). MSAF group's obligations, including its financial debt obligations, are not obligations of, or guaranteed by, MSDW, MSDWAH, MSAF Holdings, MSF or any person other than MSAF group.
The consolidated financial statements for the 12 months ended November 30, 2000 ("fiscal 2000"), November 30, 1999 ("fiscal 1999") and November 30, 1998 ("fiscal 1998") are prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the financial statements and related disclosures. Management believes that the estimates utilized in the preparation of the consolidated financial statements are prudent and reasonable. Actual results could differ materially from these estimates.
All material intercompany transactions have been eliminated.
Certain reclassifications have been made to prior year amounts to conform to the current presentation.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid investments with a maturity of three months or less.
REVENUE RECOGNITION
Revenue from aircraft on operating leases is recognized on a straight-line basis.
Certain lease contracts may require the lessee to make separate payments for flight hours flown and revenue sector passenger miles flown. In such instances, MSAF group recognizes rental revenues as they are earned in accordance with the terms of the lease contract.
AIRCRAFT
Aircraft, including engines, are stated at cost less accumulated depreciation. Cost is comprised of the cash purchase price paid plus any maintenance liabilities that MSAF group assumed from the seller at the date of purchase. Depreciation is calculated on a straight line basis. The estimates of useful lives and residual values are reviewed periodically. The current estimates for residual values are generally 10% of cost and useful lives are generally 25 years from the date of manufacture.
In accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"), the recognition of an impairment loss for an asset held for use is required when the estimate of undiscounted future cash flows expected to be generated by the asset is less than its carrying amount. Measurement of impairment loss is to be recognized based on the fair value of the asset. Fair value reflects the underlying
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED) economic value of the aircraft, including engines, in normal market conditions (where supply and demand are in reasonable equilibrium) and assumes adequate time for a sale and a willing buyer and seller. Short-term fluctuations in the market place are disregarded and it is assumed that there is no necessity either to dispose of a significant number of aircraft simultaneously or to dispose of aircraft quickly. The fair value of the assets is based on independent valuations of the aircraft in the fleet and estimates of discounted future cash flows. SFAS 121 also requires that long-lived assets to be disposed of be reported at the lower of the carrying amount or fair value less estimated disposal costs. At November 30, 2000 and November 30, 1999, no impairment losses had been recognized.
LIABILITY FOR MAINTENANCE
In most lease contracts the lessee has the obligation for maintenance costs on airframes and engines. In many lease contracts the lessee makes a full or partial prepayment to the lessor, calculated at an hourly rate, which is used to reimburse the lessee for significant maintenance charges, including major airframe and engine overhauls. Such prepayments are generally non-refundable. MSAF group records the cash prepayments made by lessees for maintenance as a component of the liability for maintenance account which appears on the Consolidated Balance Sheets. When the lessee incurs maintenance expenditures, MSAF group must return a corresponding amount of the prepayment to the lessee. At this time, MSAF group will forward cash to the lessee, with a corresponding decrease to the liability for maintenance account. MSAF group will only reimburse the lessee for the cost of maintenance expenditures to the extent that sufficient prepayments have been made by the lessee. At the time an aircraft is re-leased to a new lessee, an assessment is made of the expected maintenance reserve requirements; any excess reserve is then released to lease income.
MSAF group also estimates the amount of maintenance expenditures for which it will have primary responsibility. Such expenditures typically are required when an aircraft must be prepared prior to the commencement of a new lease. MSAF group also makes estimates of the amounts that, in certain circumstances (including lessees defaulting on payment obligations), could result in MSAF group incurring maintenance costs which are the lessee's primary responsibility. When MSAF group determines that it will be primarily responsible for certain maintenance expenditures, the amount of such expenditure is charged directly to earnings and is included as a component of the liability for maintenance account appearing on the Consolidated Balance Sheets.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Allowances are made for doubtful accounts where it is considered that there is a significant risk of non-recovery. The assessment of risk of non-recovery is primarily based on the extent to which amounts outstanding exceed the expected value of security deposits held (if any), together with an assessment of the financial strength and condition of a lessee and the economic conditions existing in the lessee's operating environment. At November 30, 2000, MSAF group had recorded allowances for doubtful accounts against lease income receivables totalling $0.3 million. The allowance for doubtful accounts at November 30, 1999 totalled $0.4 million.
INCOME TAXES
MSAF is a Delaware business trust treated as a branch of MSF for U.S. Federal, State and local income tax purposes. Accordingly, MSAF is not subject to U.S. Federal, State and local income taxes.
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED) CONCENTRATIONS OF CREDIT RISK
Credit risk with respect to operating lease receivables is generally diversified due to the number of lessees comprising MSAF group's customer base and the different geographic areas in which they operate. At November 30, 2000 MSAF group had leased 57 aircraft and one engine to 41 lessees in 26 countries. The geographic concentrations of MSAF group's leasing revenues is set forth in Note 6.
Many of MSAF group's lessees are in a relatively weak financial position because of the difficult economic conditions in the civil aviation industry as a whole and because, in general, weakly capitalized airlines are more likely to seek operating leases. In addition, at November 30, 2000, 18 of MSAF group's aircraft are being leased to lessees domiciled in certain emerging markets nations, including those located in Eastern Europe, Latin America and Asia. The exposure of MSAF group's aircraft to particular countries and customers is managed partly through concentration limits and through obtaining security from lessees by way of deposits. MSAF group will continue to manage its exposure to particular countries, regions and lessees through concentration limits.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133", which deferred the effective date of SFAS No. 133 for one year to fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities--an amendment of FASB Statement No. 133". MSAF group adopted SFAS No. 133, as amended by SFAS No. 138, effective December 1, 2000.
MSAF group estimates that it will record an increase to other liabilities (reflecting the fair value of its outstanding swaps) and a corresponding charge to other comprehensive income (a component of beneficial interestholder's equity) of $31 million from the cumulative effect of the adoption of SFAS No. 133, as amended. MSAF group's adoption of SFAS No. 133, as amended, will primarily affect the accounting for, among other things, MSAF group's derivatives used in connection with its interest rate risk management policies.
In fiscal 1999, MSAF group adopted SFAS No. 130, "Reporting Comprehensive Income", which establishes the standards for the reporting and presentation of comprehensive income. MSAF group does not have any items affecting comprehensive income. Accordingly, MSAF group's comprehensive (loss) income was equal to its net (loss) income for all periods presented. In fiscal 2001 MSAF group will have additional items in other comprehensive income due to the adoption of SFAS No. 133, as amended.
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 3--AIRCRAFT
During fiscal 2000, MSAF group acquired a portfolio of 29 commercial aircraft from MSF (see Note 13). In addition, during fiscal 2000, an aircraft that was previously subject to a sales-type capital lease was repossessed and the related lease was terminated (see Note 4). This aircraft has been included as a component of aircraft cost as of the date of repossession.
FLEET ANALYSIS:
At November 30, 2000 there were 4 non-revenue earning aircraft in MSAF group's portfolio. One of these was subject to a lease agreement and the other 3 were undergoing maintenance work. At November 30, 1999 there was 1 non-revenue earning aircraft in MSAF group's portfolio.
NOTE 4--INVESTMENT IN CAPITAL LEASE
The lessee associated with this capital lease had been experiencing severe financial difficulties during fiscal 1999, due to the economic uncertainty in Latin America and the devaluation of the Brazilian currency in January, 1999. In August 1999, MSAF group and the lessee agreed to modify the terms of the capital lease by increasing the total rental payments to be received and by extending the lease term.
The lessee's financial difficulties continued in fiscal 2000. As a result, in April 2000, International Lease Finance Corporation ("ILFC"), the servicer of MSAF group's aircraft portfolio, repossessed the aircraft from the lessee and terminated the capital lease contract. Accordingly, MSAF group's net investment in the capital lease as of the date of termination of $17.0 million has been reclassified to "Aircraft under operating leases, net" (see Note 3).
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 5--LEASE INCOME RECEIVABLE
Lease income receivable was as follows:
Activity in the allowance for doubtful accounts was as follows:
The provision for doubtful accounts of $1.5 million and $3.1 million in fiscal 2000 and fiscal 1999, respectively, are recorded as a reduction of lease income revenues in the Consolidated Statements of Operations.
NOTE 6--REVENUES
The distribution of lease revenues by geographic area is as follows:
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 6--REVENUES - (CONTINUED) At November 30, 2000, MSAF group had contracted to receive the following minimum rentals under operating leases (Dollars in millions):
NOTE 7--LIABILITY FOR MAINTENANCE
Activity in the liability for maintenance account was as follows:
NOTE 8--NOTES PAYABLE
On March 3, 1998, MSAF group completed an offering of $1,050 million of securitized notes (the "1998 Notes") on a basis exempt from registration under the Securities Act of 1933, as amended. During fiscal 1999, MSAF group filed a registration statement with the Securities and Exchange Commission (the "SEC") with respect to an exchange offer for exchange notes with terms virtually identical to the 1998 Notes which was declared effective on January 12, 1999. The exchange offer was consummated on January 18, 1999.
On March 15, 2000, MSAF group completed an offering of $1,310 million of securitized notes (the "2000 Notes") on a basis exempt from registration under the Securities Act of 1933, as amended. MSAF group used the net proceeds from the 2000 Notes to finance in part the acquisition of the 29 commercial aircraft from MSF, to fund an increase of $5 million in cash and cash equivalents used for liquidity purposes (see "Financial Resources and Liquidity--Liquidity Reserve Amount") and to redeem all $400 million of its subclass A-1 notes. The 2000 Notes rank equally in right of payment of principal and interest with the corresponding subclasses of MSAF group's existing 1998 Notes. During fiscal 2000, MSAF group filed a registration statement with the SEC with respect to an exchange offer for exchange notes with terms virtually identical to the 2000 Notes which was declared effective on October 31, 2000. The exchange offer was consummated on December 4, 2000.
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 8--NOTES PAYABLE - (CONTINUED)
With the exception of MSAF group, the 1998 Notes and the 2000 Notes (collectively, the "Notes") are not obligations of, or guaranteed by, MSDW, MSDWAH, MSAF Holdings, MSF or any person other than MSAF group.
Underwriting and financing costs which were incurred in connection with the Notes are being amortized over the expected life of the borrowings to which they relate.
The repayment terms of each subclass of Notes are such that certain principal amounts are expected to be repaid based on certain assumptions (the "Expected Final Payment Date") or refinanced through the issuance of refinancing notes, but in any event are ultimately due for repayment on specified final maturity dates (the "Final Maturity Date"). The Expected Final Payment Dates, Final Maturity Dates and interest rates applicable to each subclass of the Notes are listed below:
If the subclass A-3, A-4 or B-2 notes are not repaid on or before their respective Expected Final Payment Dates, MSAF group will pay additional interest of 1.00% per annum on the subclass A-3 and A-4 notes and 1.50% per annum on the subclass B-2 notes, until such notes are repaid in full.
The dates on which principal repayments on the Notes will actually occur will depend on the cash flows generated by the rental income from MSAF group's portfolio of aircraft. Amounts received by MSAF group are available for distribution and are paid in accordance with the priorities specified in the indenture relating to the Notes.
Cash paid for interest on the Notes amounted to $108.7 million for the fiscal year ended November 30, 2000, as compared to $58.5 million for the fiscal year ended November 30, 1999. The interest expense for fiscal 2000 is not comparable to fiscal 1999 as the 2000 Notes were issued on March 15, 2000.
The estimated fair value of MSAF group's outstanding Notes was $1,733.2 million and $902.9 million at November 30, 2000 and November 30, 1999, respectively.
NOTE 9--LIQUIDITY FACILITIES
MSAF group requires liquidity in order to finance many of its primary business activities, including maintenance obligations, security deposit return obligations, operating expenses and obligations under the Notes. MSAF group's primary sources of liquidity are cash bank deposits and letters of credit.
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 9--LIQUIDITY FACILITIES - (CONTINUED) MSAF group's cash account (the "Collection Account") is primarily funded through the receipt of rental payments from lessees.
MSAF group has entered into two credit agreements. Under a Custody and Loan Agreement (the "ILFC Facility") between ILFC and MSAF group, ILFC will hold substantially all of the cash security deposits paid by certain lessees with respect to MSAF group's aircraft portfolio and will retain the interest earnings on such security deposits. In addition, ILFC has agreed to extend loans to MSAF group in a maximum amount of $20 million plus the aggregate amount of cash security deposits held by ILFC. Under a Loan Agreement (the "MSDW Facility") between MSDW and MSAF group, MSDW has agreed to extend loans in a maximum amount of $30 million.
As of November 30, 2000, the aggregate amount available under the ILFC Facility and the MSDW Facility was approximately $70.4 million.
NOTE 10--DERIVATIVE FINANCIAL INSTRUMENTS
The leasing revenues of MSAF group are generated primarily from rental payments. Rental payments are currently entirely fixed but may be either fixed or floating with respect to leases entered into in the future. In general, an interest rate exposure with respect to the Notes payable arises to the extent that MSAF group's fixed and floating interest obligations in respect of the Notes do not correlate to the mix of fixed and floating rental payments for different rental periods. This interest rate exposure with respect to the Notes payable can be managed through the use of interest rate swaps and other derivative instruments. The subclass A-2, A-3, A-4, A-5, B-1 and B-2 notes bear floating rates of interest and the subclass C-1, C-2 and D-1 notes bear fixed rates of interest. MSAF group is a party to twelve interest rate swaps with Morgan Stanley Capital Services Inc. ("MSCS"), a wholly-owned subsidiary of MSDW. In ten of these swaps, MSAF group pays a fixed monthly coupon and receives one month LIBOR on a total notional balance of $1,300 million and in two of these swaps, MSAF group pays one month LIBOR and receives a fixed monthly coupon on a total notional balance of $200 million. During fiscal 2000, MSAF group was a party to one additional interest rate swap with MSCS with a notional balance of $300 million that matured on November 15, 2000. In this swap MSAF group paid a fixed monthly coupon and received one month LIBOR.
Eight of the swaps, having an aggregate notional principal amount of $1,100 million, are accounted for as hedges of the Notes. Under these swap arrangements, MSAF group pays fixed amounts (based upon annual interest rates ranging from 6.22% to 7.46%) and receives floating amounts (based upon one month LIBOR) on a monthly basis. The fair value of the liability assumed relating to those swaps which are being accounted for as hedges is being deferred and recognized when the offsetting gain or loss is recognized on the hedged transaction. This amount and the differential payable or receivable on such interest rate swap contracts, to the extent such swaps are deemed to be hedges, are recognized as adjustments to interest expense. Gains and losses resulting from the termination of such interest rate swap contracts prior to their stated maturity are deferred and recognized when the offsetting gain or loss is recognized on the hedged transaction. The maturity dates of these swap positions range from November, 2002 to November, 2019. The fair value of these interest rate swaps at November 30, 2000 was ($31.3) million.
The remaining four swaps have an aggregate gross notional principal amount of $400 million. Under these swap arrangements, MSAF group pays/receives fixed and receives/pays floating amounts on a monthly basis. MSAF group has determined that these swaps do not qualify for hedge accounting. The fair value of the liability assumed related to these swaps is accounted for on a mark-to-market basis with
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 10--DERIVATIVE FINANCIAL INSTRUMENTS - (CONTINUED) changes in fair value reflected in interest expense. At November 30, 2000, the fair value of these swaps was $(6.0) million.
The change in fair value of the twelve interest rate swaps between November 30, 1999 and November 30, 2000 was due to changes in market interest rates and payments being made under the swaps when they became due.
The gross notional amounts of these swaps are indicative of MSAF group's degree of use of such swaps but do not represent MSAF group's exposure to credit or market risk. Credit risk arises from the failure of the counterparty to perform according to the terms of the swap contract. MSAF group's exposure to credit risk at any point in time is represented by the fair value of the swap contracts reported as assets. MSAF group does not currently require collateral to support swap contracts with credit risk. The credit risk of these swap contracts is monitored by MSAF group's trustees.
MSAF group does not utilize derivative financial instruments for trading purposes.
NOTE 11--RELATED PARTY TRANSACTIONS
Under service agreements with MSAF group, Cabot Aircraft Services Limited and Morgan Stanley & Co. Incorporated, both subsidiaries of MSDW, act as Administrative Agent and Financial Advisor, respectively. During Fiscal 2000, Cabot Aircraft Services Limited received a fee of $1.3 million for providing these services, which is calculated as a percentage of the operating lease rentals received. Morgan Stanley & Co. Incorporated received advisory fees of $0.05 million in this period.
Simultaneous with the issuance of the 2000 Notes and the acquisition of certain net assets from MSF, MSAF Group received a non-cash capital contribution of $78.0 million from MSF.
In connection with the issuance of the 2000 Notes, MSAF group paid $5.9 million in subscription discounts and commissions to subsidiaries of MSDW.
MSAF group's counterparty to its interest rate swap agreements is MSCS, a wholly-owned subsidiary of MSDW.
In connection with the offering of the 2000 Notes, on March 15, 2000, MSF transferred the beneficial interest of MSAF group to MSDWAH, a wholly-owned subsidiary of MSF, and the number of trustees of MSAF group was increased to seven.
On October 12, 2000, MSDWAH transferred the beneficial interest in MSAF group to MSAF Holdings, a wholly owned subsidiary of MSDWAH, which is in turn a wholly owned subsidiary of MSF.
At November 30, 2000, MSAF group's management was comprised of seven trustees, including the Delaware trustee, as MSAF group has no employees or executive officers. Four of MSAF group's seven trustees were employees of MSDW. The two remaining trustees and the Delaware trustee were unaffiliated with MSDW.
NOTE 12--COMMITMENTS AND CONTINGENCIES
MSAF group did not have any material contractual commitments for capital expenditures at November 30, 2000.
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 12--COMMITMENTS AND CONTINGENCIES - (CONTINUED) In accordance with the terms of a second amended and restated servicing agreement (the "Servicing Agreement"), ILFC is performing certain aircraft related activities with respect to MSAF group's aircraft portfolio. Such activities include marketing MSAF group's aircraft for lease or sale and monitoring lessee compliance with lease terms including terms relating to payment, maintenance and insurance. In accordance with the Servicing Agreement, fees payable to ILFC by MSAF group are calculated as a percentage of the lease rentals contracted and received, in addition to a base fee and certain incentive-based fees.
For the initial 32 aircraft and one engine, the Servicing Agreement will expire in May 26, 2023. For the additional 29 aircraft acquired in fiscal 2000, the Servicing Agreement will expire on May 1, 2025. However, each party has the right to terminate the Servicing Agreement under certain circumstances.
NOTE 13--ACQUISITION OF NET ASSETS
During fiscal 2000, MSAF group acquired a portfolio of 29 commercial aircraft, as well as certain other assets and liabilities related to these aircraft, from MSF. The assets and liabilities acquired have been recorded at MSF's historical book value at the date of purchase. A summary of the net assets acquired is presented below:
MSAF group financed the acquisition with the net proceeds of the 2000 Notes (see Note 8) and a non-cash capital contribution from MSF. MSAF group's fiscal 2000 results include the revenues and expenses associated with these 29 aircraft since March 15, 2000, the date of acquisition.
The following unaudited summarized proforma consolidated results of operations data for year-ended November 30, 2000 and 1999 assumes the acquisition of the aircraft had occurred on December 1, 1998:
The summarized proforma consolidated results of operations data does not purport to represent what MSAF group's results of operations would have actually been if the acquisition in fact had occurred at the date indicated or to project MSAF group's results of operations at any future date or for any future period.
MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 14--QUARTERLY DATA (UNAUDITED)
During the fourth quarter ended November 30, 1999, maintenance and other aircraft related costs included the reversal of certain provisions made in the previous quarter relating to maintenance costs that were subsequently paid by the lessee.
MORGAN STANLEY AIRCRAFT FINANCE CASH ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(1) TWELVE MONTH PERIOD FROM DECEMBER 1999 TO NOVEMBER 2000
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(1) This report was filed with the Securities and Exchange Commission on Form 8-K on February 13, 2001. All information contained in it is as of February 1, 2001.
A-1
CONTENTS
I BACKGROUND AND GENERAL INFORMATION
II(a) COMPARISON OF ACTUAL CASH FLOWS VERSUS THE 1998 BASE CASE FOR THE FOUR MONTH PERIOD FROM DECEMBER 1999 TO MARCH 2000
II(b) COMPARISON OF ACTUAL CASH FLOWS VERSUS THE 2000 BASE CASE FOR THE EIGHT MONTH PERIOD FROM APRIL 2000 TO NOVEMBER 2000
III OTHER FINANCIAL DATA
IV RECENT DEVELOPMENTS
V APPENDICES
A-2
I BACKGROUND AND GENERAL INFORMATION
Morgan Stanley Aircraft Finance ("MSAF"), a Delaware business trust, is a special purpose vehicle which owns aircraft subject to operating leases. Under the terms of its Indenture, MSAF may acquire additional aircraft and sell aircraft from the fleet. Any acquisition of additional aircraft will be subject to certain confirmations with respect to the Notes from rating agencies and compliance with certain operating covenants of MSAF as set out in the Indenture.
INITIAL PORTFOLIO
On March 3, 1998, MSAF issued $1,050 million of Notes in connection with its acquisition of 33 aircraft plus an engine with a total appraised value as of September 30, 1997 of $1,115.5 million from International Lease Finance Corporation ("ILFC"). All but one of the 33 aircraft were acquired by MSAF with an appraised value of $1,086.9 million as of September 30, 1997.
NEW ISSUANCE
On March 15, 2000, MSAF refinanced the A-1 subclass Notes of $400 million as part of a total issuance of $1,310 million of New Notes in five subclasses (A-3, A-4, A-5, B-2 and C-2). In addition to the refinancing of the A-1 subclass, the New Notes were issued in association with MSAF's acquisition of 29 aircraft with a total appraised value of $1,047.8 million as of November 30, 1999 from a subsidiary of Morgan Stanley Dean Witter & Co. ("MSDW"). MSDW acquired two aircraft from an affiliate of GE Capital Corporation on March 19, 1999 and 27 aircraft from ILFC on August 6, 1999.
COMBINED PORTFOLIO
As a result of the March 2000 acquisition, the overall size of MSAF's combined aircraft fleet is now 61 aircraft plus an engine with a total appraised value of $1,911.2 million as of September 30, 2000. As of February 1, 2001, MSAF had 60 lease contracts in effect with 42 lessees based in 27 countries as shown in Appendix A. Under one of the leases, the lessee has not yet taken delivery of the aircraft. The aircraft, an A320-200, is due to be delivered to the lessee in late February 2001.
MANAGEMENT DISCUSSION AND ANALYSIS
The discussion and analysis that follows in Section II and III is based on the results of MSAF and its subsidiaries as a single entity (collectively the "MSAF GROUP") for the reporting period December 1999 to November 2000.
Section II (a) covers the four month period, December 1999 to March 2000, prior to the New Issuance and the aircraft acquisition on March 15, 2000 and therefore relates to the Initial Portfolio of 32 aircraft plus an engine. The cash flows over this four month period are compared against the 1998 Base Case.
For the purposes of this report, the "FOUR MONTH PERIOD", discussed in Section II (a) shall comprise information from the monthly cash reports dated December 15, 1999 to March 15, 2000. The financial data in this section includes cash receipts from November 9, 1999 (first day of the Collection Period for the December 2000 Report) up to March 9, 2000 (last day of the Collection Period for the March 2000 Report). It also includes payments made by MSAF Group between November 16, 1999 and up to March 15, 2000 (the Note Payment Date for the March 2000 Report).
Section II (b) covers the eight month period, April 2000 to November 2000, after the New Issuance and the aircraft acquisition on March 15, 2000 and therefore relates to the Combined Portfolio of 61 aircraft plus an engine. The cash flows over this eight month period are compared against the 2000 Base Case.
For the purposes of this report, the "EIGHT MONTH PERIOD", discussed in Section II (b) shall comprise information from the monthly cash reports dated April 15, 2000 to November 15, 2000. The financial data
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in this section includes cash receipts from March 10, 2000 (first day of the Collection Period for the April 2000 Report) up to November 9, 2000 (last day of the Collection Period for the November 2000 Report). It also includes payments made by MSAF Group between March 16, 2000 and up to November 15, 2000 (the Note Payment Date for the November 2000 Report).
The discussion and analysis in Section IV--"Recent Developments" relates to the Combined Portfolio of 61 aircraft plus an engine.
MSAF Group's cash receipts and disbursements are determined, in part, by the overall economic condition of the operating leasing market. The operating leasing market, in turn, is affected by various cyclical factors including the level and volatility of interest rates, the availability of credit, fuel costs and general and regional economic conditions affecting lessee operations and trading. Other factors to consider are manufacturer production levels, passenger demand, retirement and obsolescence of aircraft models, manufacturers exiting or entering the market or ceasing to produce aircraft types or re-introduction into service of aircraft previously in storage. In addition, state regulations and air traffic control infrastructure constraints, such as limitations on the number of landing slots, can also impact the operating leasing market.
MSAF Group's ability to compete against other lessors is determined, in part, (1) by the composition of its fleet in terms of mix, relative age and popularity of aircraft type (2) operating restrictions imposed by the Indenture and (3) the ability of other lessors, who may possess substantially greater financial resources, to offer leases on more favorable terms than MSAF Group.
II(a) COMPARISON OF ACTUAL CASH FLOWS VERSUS THE 1998 BASE CASE FOR THE FOUR MONTH PERIOD FROM DECEMBER 1999 TO MARCH 2000
The February 20, 1998 Offering Memorandum and the November 4, 1998 Prospectus for the Notes contain assumptions in respect of MSAF Group's future cash flows and cash expenses (the "1998 BASE CASE").
For the purpose of this section, "NET CASH COLLECTIONS" is defined as Total Cash Collections less Total Cash Expenses, Drawings from and Transfers to Expense Account, Interest Payments, Swap Payments and Exceptional Items. A discussion of the Cash Collections, Cash Expenses, Drawings from and Transfers to Expense Account, Interest Payments, Swap Payments, Exceptional Items and Principal Payments is given below and should be read in conjunction with the analysis in Appendix B.
CASH COLLECTIONS
"Total Cash Collections" includes Net Lease Rentals (Contracted Lease Rentals plus Movement in Current Arrears Balance less Net Stress-related Costs), Interest Earned, and Net Maintenance.
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In the Four Month Period, MSAF Group generated approximately $37.2 million in Total Cash Collections, $5.5 million less than assumed in the 1998 Base Case. This difference is due to a combination of the factors set out below (the numbers in brackets refer to the line item number shown in Appendix B).
[2] RENEGOTIATED LEASES
Renegotiated Leases refers to the loss in rental revenue caused by a lessee negotiating a reduction in the lease rental. Typically, this can be a permanent reduction over the remaining lease term in exchange for other contractual concessions. In the Four Month Period, the amount of revenue loss attributed to Renegotiated Leases was $0.9 million. This is mainly due to a 14% reduction from the 1998 Base Case rental on a B767-300ER on lease to Air Pacific. The new rental was reset at the then prevailing market rate for B767-300ERs in exchange for a lease extension.
[3] RENTAL RESETS
Rental Resets is a measure of the loss in rental revenue when new lease rates are lower than those assumed in the 1998 Base Case. During the Four Month Period, no new leases were written, however, lost revenue attributable to leases that had rental resets prior to the Four Month Period amounted to $0.1 million.
[4] CONTRACTED LEASE RENTALS
Contracted Lease Rentals represents the current contracted lease rental rollout which equates to the 1998 Base Case Lease Rentals less adjustments for Renegotiated Leases and Rental Resets. For the Four Month Period, Contracted Lease Rentals were $43.2 million, $1.0 million less than assumed in the 1998 Base Case. The difference is due to losses from Renegotiated Leases and Rental Resets as discussed above in line items [2] and [3].
[5] MOVEMENT IN CURRENT ARREARS BALANCE
Current Arrears refers to the total Contracted Lease Rentals outstanding from current lessees at a given date and excludes any amounts classified as Bad Debts. The Current Arrears Balance at the start of the Four Month Period was $3.0 million versus $3.2 million at the end of the Four Month Period, an increase of $0.2 million.
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* Re-classified as Bad Debts during January 2000
As at November 15, 1999, six lessees were in arrears, owing $3.0 million, against which MSAF Group held security deposits of $2.9 million. One of the six lessees, TAESA, based in Mexico, defaulted during the Four Month Period and the aircraft was repossessed. Rental arrears amounting to $0.5 million associated
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with this lessee at the time of repossession were deemed irrecoverable and reclassified from Current Arrears to Bad Debts. Additional analysis of this Bad Debt is provided below in line item [6].
As of the Noteholders Report on March 15, 2000, five lessees were in arrears, owing $3.2 million, against which MSAF Group held security deposits of $2.2 million.
NET STRESS-RELATED COSTS
Net Stress-related Costs is a combination of all the factors which can cause actual lease rentals received to differ from the Contracted Lease Rentals. The 1998 Base Case assumed Net Stress-related Costs equal to 4.5% of the 1998 Base Case Lease Rentals.
For the Four Month Period, Net Stress-related Costs amounted to $4.4 million (12.2% of Contracted Lease Rentals) compared to $2.0 million assumed in the 1998 Base Case, a variance of $2.4 million. A detailed analysis of Net Stress-related Costs is provided below in line items [6] to [11].
[6] BAD DEBTS AND [7] SECURITY DEPOSITS DRAWN DOWN
Bad Debts refers to rental arrears owed by lessees who have defaulted and which are deemed irrecoverable. These arrears are partially offset by the draw down of security deposits held and amounts subsequently recovered from the defaulted lessees. In the Four Month Period, rental arrears associated with one lessee were deemed irrecoverable and classified as Bad Debts.
During the Four Month Period, $0.5 million was written off in respect of lease rental due from a former lessee, TAESA, based in Mexico, against which MSAF Group drew down a security deposit of $0.5 million.
[8] RESTRUCTURED ARREARS
Restructured Arrears refers to current arrears that have been capitalized and restructured into a note payable, which is repaid over an agreed period. There were no losses from Restructured Arrears in the Four Month Period.
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[9] AIRCRAFT ON GROUND ("AOG")
AOG is defined as the Base Case Lease Rental lost when an aircraft is off-lease and non-revenue earning. The impact of AOG downtime amounted to lost rental of $5.4 million during the Four Month Period. This was in respect of four aircraft:
AOG ANALYSIS FOR THE FOUR MONTH PERIOD
[10] OTHER LEASING INCOME
Other Leasing Income consists of miscellaneous income received in connection with a lease other than contracted rentals, maintenance receipts and security deposits, such as early termination payments, default interest or payment for excess flight hours flown. In the Four Month Period, Other Leasing Income amounted to $1.1 million.
[11] REPOSSESSION COSTS
Repossession Costs consists of legal and aircraft technical costs incurred as a result of repossessing an aircraft. In the Four Month Period, Repossession Costs amounted to $0.1 million, which primarily related to consultancy and legal fees incurred during the repossession of the B737-400 previously on lease to TAESA and the repossession of the B747-300 previously on lease to VARIG.
[13] NET LEASE RENTALS
Net Lease Rentals is Contracted Lease Rentals plus the Movement in Current Arrears Balance less Net Stress-related Costs. In the Four Month Period, Net Lease Rentals amounted to $38.6 million, $3.6 million less than assumed in the 1998 Base Case. The variance was primarily attributable to the lost rental from AOG downtime, which is discussed above in line item [9].
[14] INTEREST EARNED
Interest Earned relates to interest received on cash balances held in the Collection and Expense Accounts. Cash held in the Collection Account in the Four Month Period consisted of the cash liquidity reserve amount of $25.0 million plus the intra-month cash balances for all the rentals and maintenance payments collected prior to the monthly payment date. The Expense Account contains cash set aside to pay for expenses which are expected to be payable over the next three months. In the Four Month Period, Interest Earned amounted to $0.7 million, $0.2 million more than assumed in the 1998 Base Case. The difference was due primarily to interest earned on the intra-month cash balances in the Collection and Expense Account. The 1998 Base Case made no assumption as to the interest earned on these balances.
[15] NET MAINTENANCE
Net Maintenance refers to maintenance receipts less any maintenance reimbursements paid to lessees. In the Four Month Period, actual maintenance receipts amounted to $3.9 million while maintenance expenditure amounted to $6.0 million, generating negative Net Maintenance of $2.1 million.
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Maintenance expenditure included costs incurred in the
- overhaul of a B757-200ER repossessed from Guyana Airways ($3.6 million)
- reimbursement from airframe reserves of $0.9 million in respect of a B767-300ER in accordance with a lease restructuring
- reimbursement from the engine reserves of $1.5 million in respect of a B737-400 previously on lease to TAESA.
The 1998 Base Case made no assumption for Net Maintenance as it assumed that, over time, maintenance receipts would equal maintenance expenditure. However, it is unlikely that in any particular Note Payment Period, maintenance receipts would exactly equal maintenance expenditure.
CASH EXPENSES
"Total Cash Expenses" includes Aircraft Operating Expenses and Selling, General and Administrative ("SG&A") Expenses. In the Four Month Period, Total Cash Expenses were $2.2 million, resulting in a $2.3 million positive variance against the 1998 Base Case, which assumed total cash expenses of $4.5 million.
AIRCRAFT OPERATING EXPENSES includes all operational costs related to the leasing of an aircraft including costs of insurance, re-leasing and other overhead costs. In the Four Month Period, Aircraft Operating Expenses amounted to $0.1 million, $1.4 million less than the 1998 Base Case, which assumed these costs to be 3.5% of the 1998 Base Case Lease Rentals. The variance is discussed below in line items [17] to [18].
[17] INSURANCE
No insurance costs were incurred in the Four Month Period.
[18] RE-LEASING AND OTHER OVERHEAD COSTS
Re-leasing and other overhead costs consists of miscellaneous re-delivery and leasing costs associated with re-leasing events. In the Four Month Period these costs amounted to $0.1 million, mainly relating to costs incurred in the re-leasing of two A310-300s, previously on lease to Oman Air.
SG&A EXPENSES relates to fees paid to the Aircraft Servicer and to other service providers. In the Four Month Period, SG&A Expenses were $2.1 million, $0.9 million lower than assumed in the 1998 Base Case. The variance is described below in line items [20] and [21].
[20] AIRCRAFT SERVICER FEES
Aircraft Servicer Fees is defined as amounts paid to the Aircraft Servicer, ILFC, in accordance with the terms of the Servicing Agreement. In the Four Month Period, total Aircraft Servicer Fees paid was $1.4 million, $0.5 million less than the 1998 Base Case assumptions, reflecting lower actual rentals achieved and high AOG downtime.
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Aircraft Servicer Fees consist of:
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* FOR FINANCIAL YEAR ENDED NOVEMBER 30, 2000
The Base Fee is a fixed amount per month per aircraft and changes only as aircraft are acquired or sold. The Rent Contracted Fee is equal to 1.0% of all rentals contracted in the current calendar month. The Rent Collected Fee is equal to approximately 1.0% of all rentals received during the previous calendar month. The Incentive Fee applies to the Initial Portfolio only and is set at 10% of all cash flow received above a targeted annual amount set in the Operating Budget at the beginning of each financial year. No Incentive Fee was payable to ILFC in the Four Month Period for the financial year ended November 2000.
[21] OTHER SERVICER FEES
Other Servicer Fees relates to fees and expenses paid to other service providers including the Administrative Agent, Financial Advisor, legal advisors, accountants and Independent Trustees. In the Four Month Period, Other Servicer Fees amounted to $0.7 million as compared to an assumed expense of $1.1 million in the 1998 Base Case, a positive variance of $0.4 million.
NET CASH COLLECTIONS
"Net Cash Collections" equals Total Cash Collections less Total Cash Expenses, Drawings from and Transfers to Expense Account, Interest Payments, Swap Payments and Exceptional Items.
[23] TOTAL CASH COLLECTIONS
As discussed in line items [2] to [15], MSAF Group generated approximately $37.2 million in Total Cash Collections, $5.5 million less than assumed in the 1998 Base Case.
[24] TOTAL CASH EXPENSES
As discussed in line items [17] to [21], MSAF Group incurred approximately $2.2 million in Total Cash Expenses, $2.3 million lower than assumed in the 1998 Base Case.
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[25] DRAWINGS FROM EXPENSE ACCOUNT
The Expense Account contains cash set aside each month from current cash collections to pay for expenses which are expected to be payable over the next three months. The Administrative Agent determines the level of cash set aside each month. In the Four Month Period, $6.4 million was drawn from the Expense account to pay for expenses incurred and which were payable during the period. The 1998 Base Case made no assumption as to the level of these Drawings.
[26] TRANSFERS TO EXPENSE ACCOUNT
Transfers to the Expense Account represents the level of cash set aside each month to pay for expenses which are expected to be payable over the next three months. During the Four Month Period, $8.6 million was transferred to the Expense Account. As at March 15, 2000, the closing balance in the Expense Account was $5.8 million.
[27] INTEREST PAYMENTS AND [28] SWAP PAYMENTS
In the Four Month Period, Interest Payments to Noteholders amounted to $20.6 million. This was $0.2 million higher than the 1998 Base Case, which assumed Interest Payments to be $20.4 million. While the total debt balance outstanding during the Four Month Period was lower than expected in the 1998 Base Case, Interest Payments rose due to a higher than assumed average LIBOR. The average LIBOR for the Four Month Period was 5.88% versus an assumed LIBOR of 5.75%.
The higher Interest Payments were offset by a reduction in the amount of Swap Payments. MSAF Group paid $0.9 million in Swap Payments, $0.4 million less than assumed in the 1998 Base Case.
[29] EXCEPTIONAL ITEMS
Exceptional Items refers to cash flows that occur infrequently and are outside the normal business activities of MSAF Group. There were no exceptional cash flows in the Four Month Period.
[31] PRINCIPAL PAYMENTS
In the Four Month Period, total Principal Payments to Noteholders amounted to $11.3 million, $5.2 million lower than assumed in the 1998 Base Case. This reflects the lower Net Cash Collections available during the Four Month Period, mainly as a result of the lower than expected lease revenue performance.
II(b) COMPARISON OF ACTUAL CASH FLOWS VERSUS THE 2000 BASE CASE FOR THE EIGHT MONTH PERIOD FROM APRIL 2000 TO NOVEMBER 2000
The March 8, 2000 Offering Memorandum and the October 31, 2000 Prospectus for the New Notes contain assumptions in respect of MSAF Group's future cash flows and cash expenses (the "2000 BASE CASE"). For the purpose of this report, "NET CASH COLLECTIONS" is defined as Total Cash Collections less Total Cash Expenses, Drawings from and Transfers to Expense Account, Interest Payments, Swap Payments and Exceptional Items. A discussion of the Cash Collections, Cash Expenses, Drawings from and Transfers to Expense Account, Interest Payments, Swap Payments, Exceptional Items and Principal Payments is given below and should be read in conjunction with the analysis in Appendix C.
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CASH COLLECTIONS
"Total Cash Collections" includes Net Lease Rentals (Contracted Lease Rentals plus Movement in Current Arrears Balance less Net Stress-related Costs), Interest Earned, and Net Maintenance.
In the Eight Month Period, MSAF Group generated approximately $165.5 million in Total Cash Collections, $10.4 million more than assumed in the 2000 Base Case. This difference is due to a combination of the factors set out below (the numbers in brackets refer to the line item number shown in Appendix C).
[2] RENEGOTIATED LEASES
Renegotiated Leases refers to the loss in rental revenue caused by a lessee negotiating a reduction in the lease rental. Typically, this can be a permanent reduction over the remaining lease term in exchange for other contractual concessions. During the Eight Month Period, one lease was renegotiated, resulting in a small decrease in the present value of the rental cash flows over the lease term. The new rental was agreed in exchange for an extension of the lease term.
[3] RENTAL RESETS
Rental Resets is a measure of the loss in rental revenue when new lease rates are lower than those assumed in the 2000 Base Case. During the Eight Month Period, one lease was extended on a power by hour basis, which resulted in lost rental of $0.1 million when compared against the 2000 Base Case assumptions for this aircraft. See Section IV--"Recent Developments" for a discussion of current re-leasing events as of February 1, 2001.
[4] CONTRACTED LEASE RENTALS
Contracted Lease Rentals represents the current contracted lease rental rollout which equates to the 2000 Base Case Lease Rentals less adjustments for Renegotiated Leases and Rental Resets. For the Eight Month Period, Contracted Lease Rentals were $160.6 million, slightly lower than assumed in the 2000 Base Case.
[5] MOVEMENT IN CURRENT ARREARS BALANCE
Current Arrears refers to the total Contracted Lease Rentals outstanding from current lessees at a given date and excludes any amounts classified as Bad Debts. Movement in Current Arrears Balance measures the difference in arrears balances between the start of the 2000 Base Case, March 15, 2000, and
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November 15, 2000. For the purposes of the 2000 Base Case only, Current Arrears Balance at the New Issuance date (March 15, 2000) was assumed to be nil. Actual Current Arrears were $3.2 million as of March 15, 2000 and these pertain to the Initial Portfolio only. Actual Current Arrears as of November 15, 2000 were $0.7 million and relate to the Combined Portfolio.
As of the Noteholders Report on November 15, 2000, one lessee was in arrears, owing $0.7 million, against which MSAF Group held security deposits of $0.7 million. See Section IV--"Recent Developments" for a discussion of the total Current Arrears as of February 1, 2001.
NET STRESS-RELATED COSTS
Net Stress-related Costs is a combination of all the factors which can cause actual lease rentals received to differ from the Contracted Lease Rentals. The 2000 Base Case assumes Net Stress-related Costs equal to 4.5% of the 2000 Base Case Lease Rentals.
For the Eight Month Period, Net Stress-related Costs amounted to income of $3.3 million, $10.6 million greater than the 2000 Base Case. A detailed analysis of Net Stress-related Costs is provided below in line items [6] to [11].
[6] BAD DEBTS AND [7] SECURITY DEPOSITS DRAWN DOWN
Bad Debts refers to rental arrears owed by lessees who have defaulted and which are deemed irrecoverable. These arrears are partially offset by the draw down of security deposits held and amounts subsequently recovered from the defaulted lessees. In the Eight Month Period, rental arrears associated with two lessees were deemed irrecoverable and classified as Bad Debts.
One of the two lessees based in Brazil, B.R.A., defaulted on its obligations under its lease of an A310-300 and the aircraft was repossessed in May, 2000. The lease was scheduled to expire in July 2007. Rental arrears, associated with the lessee, at the time of repossession amounted to $1.3 million and were re-classified from Current Arrears to Bad Debts during the Eight Month Period. There was no security deposit held by MSAF Group to offset against the arrears balance.
A second Brazilian lessee, VASP, defaulted on its obligations under its lease of a B737-300 and the aircraft was repossessed in May, 2000, following legal proceedings against VASP. The lease was scheduled to expire in March 2003. Rental arrears, associated with the lessee, at the time of repossession amounted to $0.5 million and were re-classified from Current Arrears to Bad Debts during the Eight Month Period.
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A security deposit of $0.7 million, held by MSAF Group, was drawn down against this lessee, covering the arrears and a portion of the expenditure incurred in returning the aircraft to a deliverable condition.
[8] RESTRUCTURED ARREARS
Restructured Arrears refers to current arrears that have been capitalized and restructured into a note payable, which is repaid over an agreed period. There were no losses from Restructured Arrears in the Eight Month Period.
[9] AIRCRAFT ON GROUND ("AOG")
AOG is defined as the Base Case Lease Rental lost when an aircraft is off-lease and non-revenue earning. The impact of AOG downtime amounted to lost rental of $4.7 million during the Eight Month Period. This was in respect of six aircraft:
AOG ANALYSIS FOR THE EIGHT MONTH PERIOD
See Section IV--"Recent Developments" for an analysis of AOG as of February 1, 2001.
[10] OTHER LEASING INCOME
Other Leasing Income consists of miscellaneous income received in connection with a lease other than contracted rentals, maintenance receipts and security deposits, such as early termination payments, default interest or payment for excess flight hours flown. In the Eight Month Period, Other Leasing Income amounted to $9.1 million. This primarily relates to
- $4.2 million received in respect of an insurance claim submitted for the maintenance work, repairs and services required to reconstruct the technical records following repossession of a B757-200ER from Guyana Airways
- $3.0 million received in connection with MSAF's original purchase of an A340-300
- $1.0 million received in connection with MSAF's original purchase of an A330-300.
- $0.6 million received for excess flight hours flown by four aircraft on lease to four different lessees
- $0.3 million received from a lessee in respect of the fee payable upon exercise of an early termination option
[11] REPOSSESSION COSTS
Repossession Costs consists of legal and aircraft technical costs incurred as a result of repossessing an aircraft. In the Eight Month Period, Repossession Costs amounted to $0.4 million, which primarily related to consultancy and legal fees incurred during the repossession of the A310-300 previously on lease to B.R.A., the B737-400 previously on lease to TAESA and the B737-300 previously on lease to VASP.
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[13] NET LEASE RENTALS
Net Lease Rentals is Contracted Lease Rentals plus the Movement in Current Arrears Balance less Net Stress-related Costs. In the Eight Month Period, Net Lease Rentals amounted to $163.2 million, $9.8 million greater than assumed in the 2000 Base Case. The variance was primarily attributable to the increase in Other Leasing Income, which is discussed above in line item [10].
[14] INTEREST EARNED
Interest Earned relates to interest received on cash balances held in the Collection and Expense Accounts. Cash held in the Collection Account in the Eight Month Period consisted of the cash liquidity reserve amount of $30.0 million, lessee Security Deposits of $19.2 million, plus the intra-month cash balances for all the rentals and maintenance payments collected prior to the monthly payment date. The Expense Account contains cash set aside to pay for expenses which are expected to be payable over the next three months. The average interest rate for the Eight Month Period was 6.35%, versus the interest rate of 5.77% assumed in the 2000 Base Case. In the Eight Month Period, Interest Earned amounted to $2.8 million, $1.1 million more than assumed in the 2000 Base Case. The difference was due primarily to a higher interest rate and interest earned on Other Leasing Income received during the Eight Month Period.
[15] NET MAINTENANCE
Net Maintenance refers to maintenance receipts less any maintenance reimbursements paid to lessees. In the Eight Month Period, actual maintenance receipts amounted to $19.3 million while maintenance expenditure amounted to $19.8 million, generating negative Net Maintenance of $0.5 million.
The 2000 Base Case makes no assumptions for Net Maintenance as it assumes that, over time, maintenance receipts will equal maintenance expenditure. However, it is unlikely that in any particular Note Payment Period, maintenance receipts will exactly equal maintenance expenditure.
CASH EXPENSES
"Total Cash Expenses" includes Aircraft Operating Expenses and SG&A Expenses. In the Eight Month Period, Total Cash Expenses were $8.3 million, $0.2 million greater than assumed in the 2000 Base Case, which assumes these costs to be 5.0% of the 2000 Base Case Lease Rentals.
AIRCRAFT OPERATING EXPENSES includes all operational costs related to the leasing of an aircraft including costs of insurance, re-leasing and other overhead costs. In the Eight Month Period, Aircraft Operating Expenses amounted to $0.8 million, $0.5 million less than the 2000 Base Case, which assumes these costs to be 0.8% of the 2000 Base Case Lease Rentals. The variance is discussed below in line items [17] to [18].
[17] INSURANCE
Insurance costs of $0.6 million were incurred in the Eight Month Period and related to the payment of the premium in respect of the aircraft contingent insurance program.
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[18] RE-LEASING AND OTHER OVERHEAD COSTS
Re-leasing and other overhead costs consists of miscellaneous re-delivery and leasing costs associated with re-leasing events. In the Eight Month Period these costs amounted to $0.2 million.
SG&A EXPENSES relates to fees paid to the Aircraft Servicer and to other service providers. In the Eight Month Period, SG&A Expenses were $7.5 million, $0.7 million greater than assumed in the 2000 Base Case. The variance is described below in line items [20] and [21].
[20] AIRCRAFT SERVICER FEES
Aircraft Servicer Fees is defined as amounts paid to the Aircraft Servicer, ILFC, in accordance with the terms of the Servicing Agreement. In the Eight Month Period, the total Aircraft Servicer Fees paid was $5.5 million, slightly lower than the 2000 Base Case assumptions. Aircraft Servicer Fees consist of:
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* FOR FINANCIAL YEAR ENDED NOVEMBER 30, 2000
The Base Fee is a fixed amount per month per aircraft and changes only as aircraft are acquired or sold. The Rent Contracted Fee is equal to 1% of all rentals contracted in the current calendar month. The Rent Collected Fee is equal to approximately 1.25% of all rentals received during the previous calendar month. The Incentive Fee applies to the Initial Portfolio only and is set at 10% of all cash flow received above a targeted annual amount set in the Operating Budget at the beginning of each financial year. No Incentive Fee was payable to ILFC in the Eight Month Period for the financial year ended November 2000.
[21] OTHER SERVICER FEES
Other Servicer Fees relates to fees and expenses paid to other service providers including the Administrative Agent, Financial Advisor, legal advisors, accountants and Independent Trustees. In the Eight Month Period, Other Servicer Fees amounted to $2.0 million as compared to an assumed expense of $1.2 million in the 2000 Base Case, a negative variance of $0.8 million.
NET CASH COLLECTIONS
"Net Cash Collections" equals Total Cash Collections less Total Cash Expenses, Drawings from and Transfers to Expense Account, Interest Payments, Swap Payments and Exceptional Items.
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[23] TOTAL CASH COLLECTIONS
As discussed in line items [2] to [15], MSAF Group generated approximately $165.5 million in Total Cash Collections, $10.4 million more than assumed in the 2000 Base Case.
[24] TOTAL CASH EXPENSES
As discussed in line items [17] to [21], MSAF Group incurred approximately $8.3 million in Total Cash Expenses, $0.2 million higher than assumed in the 2000 Base Case.
[25] DRAWINGS FROM EXPENSE ACCOUNT
The Expense Account contains cash set aside each month from current cash collections to pay for expenses which are expected to be payable over the next three months. The Administrative Agent determines the level of cash set aside each month. In the Eight Month Period, $22.5 million was drawn from the Expense account to pay expenses incurred and which were payable during the period. The 2000 Base Case makes no assumption as to the level of these Drawings.
[26] TRANSFERS TO EXPENSE ACCOUNT
Transfers to the Expense Account represents the level of cash set aside each month to pay for expenses which are expected to be payable over the next three months. During the Eight Month Period, $27.7 million was transferred to the Expense Account. As at November 15, 2000, the closing balance on the Expense Account was $11.0 million, which will be used to fund future cash expenses, primarily maintenance costs.
[27] INTEREST PAYMENTS AND [28] SWAP PAYMENTS
In the Eight Month Period, Interest Payments to Noteholders amounted to $88.1 million. This is $5.3 million higher than the 2000 Base Case, which assumes Interest Payments for the Eight Month Period to be $82.8 million. The higher Interest Payments are due to a higher than assumed average LIBOR. The average LIBOR for the Eight Month Period was 6.47% versus an assumed LIBOR of 5.97%.
The higher Interest Payments were partially offset by a reduction in the amount of Swap Payments. MSAF paid $2.0 million in Swap Payments, $4.8 million less than assumed in the 2000 Base Case.
[29] EXCEPTIONAL ITEMS
Exceptional Items refers to cash flows that occur infrequently and are outside the normal business activities of MSAF Group. There were no exceptional cash flows in the Eight Month Period.
[31] PRINCIPAL PAYMENTS
In the Eight Month Period, total Principal Payments to Noteholders amounted to $61.9 million, $4.5 million greater than assumed in the 2000 Base Case, reflecting the higher Net Cash Collections available during this period, offset by the increased cash balance held in the Expense Account to fund future cash expenses.
III OTHER FINANCIAL DATA
Details of interest and debt coverage ratios and Loan-to-Value ratios (LTV's) as of November 15, 2000 are shown in Appendix D.
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CASH
Cash held at November 15, 2000 was $60.2 million. This included $30.0 million representing the cash portion of the Liquidity Reserve Amount at that time. This is a source of liquidity for, among other things, maintenance obligations, operating expenses and contingent liabilities. The balance consisted of $19.2 million in lessee security deposits and $11.0 million in accrued expenses held in the Expense Account in respect of future cash expenses.
In addition to the $60.2 million cash balance held at November 15, 2000, the Liquidity Reserve Amount also contained credit and liquidity facilities provided by MSDW and ILFC aggregating to $70.0 million. Neither of these facilities was drawn upon in the Eight Month Period.
AIRCRAFT VALUES
Under the terms of the Indenture, MSAF Group is required to obtain new appraisals of the Base Value of each aircraft from a minimum of three independent appraisers each year. The annual appraisal must be delivered to the Indenture Trustee no later than October 31 of each year. The aircraft appraisals delivered to the Indenture Trustee on October 31, 2000 are shown in Appendix A.
A-D NOTE BALANCE
As of November 15, 2000, the aggregate amount of Class A-D Notes outstanding was $1,772.4 million. This is $4.5 million less than the 2000 Base Case, which assumes the aggregate amount of Class A-D Notes outstanding to be $1,776.9 million.
IV RECENT DEVELOPMENTS
The following discussion refers to information pertaining to the portfolio of 61 aircraft plus an engine which were owned by MSAF Group as of February 1, 2001.
RE-MARKETING TASK FOR COMBINED PORTFOLIO
As of February 1, 2001, two aircraft from a portfolio of 61 aircraft plus an engine were off-lease. The Servicer is currently marketing the two aircraft, an A320-300 and a B737-300.
SUMMARY
Under one of the leases, the lessee had not yet taken delivery of the aircraft. The aircraft, an A320-200, was due to be delivered to the lessee in late February 2001. Sixteen leases are scheduled to expire before December 31, 2002, of which two are subject to a non-binding letter of intent. The other leases are not yet subject to non-binding letters of intent, but the Servicer is currently negotiating lease extensions with three of the current lessees.
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RE-MARKETING TASK: BY NUMBER OF AIRCRAFT
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* INCLUDES AIRCRAFT CURRENTLY SUBJECT TO A NON-BINDING LETTER OF INTENT.
(-) INCLUDES AIRCRAFT CURRENTLY OFF-LEASE.
(+) INCLUDES AIRCRAFT THAT HAS NOT YET BEEN DELIVERED TO LESSEE.
RE-MARKETING TASK: BY APPRAISED VALUE*
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* APPRAISED VALUE AS OF SEPTEMBER 30, 2000
As of February 1, 2001, 55 leases, representing 86.39% of the portfolio by appraised value as of September 30, 2000, were scheduled to expire before December 31, 2005. As of February 1, 2001, the average remaining term to lease expiry date, weighted by appraised value as of September 30, 2000 was
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36 months. This would extend to 38 months if the two aircraft currently subject to non-binding letters of intent were progressed to signed leases.
AIRCRAFT ON GROUND (AOG)
As of February 1, 2001, there were two aircraft on the ground:
AOG ANALYSIS FEBRUARY 1, 2001
The lease in respect of the A320-200 aircraft with TransAer was terminated in October 2000. TransAer had been operating this aircraft on wet lease to Libyan Arab Airlines, which continues to detain the aircraft. MSAF believes that Libyan Arab Airlines has no right to keep possession of the aircraft. The Servicer has submitted an insurance claim for the loss of the aircraft, which is currently pending. The Servicer also continues to explore recovery options consistent with compliance with United States law. MSAF may incur significant costs and time in resolving this matter. This aircraft represents 1.7% of the portfolio by appraised value as of September 30, 2000
The B737-300 aircraft was repossessed from VASP in May 2000. The aircraft cannot be released until it has been deregistered from the Brazilian registry. As a result of VASP's non-cooperation in completing deregistration, a court order is necessary to complete the process. This aircraft represents approximately 1.0% of the portfolio by appraised value as of September 30, 2000.
LESSEE DIFFICULTIES
As of February 1, 2001, seven lessees were in arrears. The ten aircraft on lease to these lessees represented 13.7% of the portfolio by appraised value as of September 30, 2000. The total Current Arrears amount with respect to these seven lessees was $6.4 million, of which $4.7 million related to rental payments and $1.7 million related to maintenance reserves. MSAF Group held security deposits of $4.8 million against these arrears. The Current Arrears amount represented 2.0% of annual lease rental payments. The weighted average number of days past due of such arrears was 61 days.
The categorization of countries into the geographical regions of Developed Markets, Emerging Markets and Other is determined using Morgan Stanley Capital International, Inc. ("MSCI") designations. A regional analysis of Current Arrears as of February 1, 2001 is shown below.
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EUROPE (DEVELOPED)
MSAF Group currently leases 23.1% of the portfolio by appraised value as of September 30, 2000 in the Europe (Developed) region. One of the seven lessees currently in arrears is based in this region.
As of February 1, 2001, KLM, a lessee based in the Netherlands, owed rental arrears of $0.1 million in respect of an engine against which MSAF Group held a security deposit of $0.1 million. This asset, a GE Engine, represents 0.3% of the portfolio by appraised value as of September 30, 2000.
NORTH AMERICA (DEVELOPED)
MSAF Group currently leases 15.4% of the portfolio by appraised value as of September 30, 2000 in the North America (Developed) region. Two of the seven lessees currently in arrears are based in the North America region.
As of February 1, 2001, TWA, a lessee based in the U.S.A., owed rental arrears of $1.3 million in respect of 4 aircraft against which MSAF Group held security deposits of $2.0 million. On January 10, 2001, TWA announced that it and certain of its subsidiaries had voluntarily filed petitions in the U.S. District Court in Wilmington, Delaware for relief under Chapter 11 of the U.S. Bankruptcy Code. TWA also announced that it had reached agreement with American Airlines, Inc. ("American"), in which American would acquire substantially all the assets of TWA. MSAF Group currently has 4 aircraft on lease to TWA, or approximately 5.1% of the fleet by appraised value as of September 30, 2000. The four aircraft are: one Boeing 757-200ER, two MD-83s and one MD-82. MSAF Group is not yet aware as to whether TWA intends to affirm or reject some or all of these leases in its bankruptcy proceeding or how the agreement between American and TWA may impact these leases.
As of February 1, 2001, National Airlines, a lessee based in the U.S.A., owed rental arrears of $1.0 million against which MSAF Group held a security deposit of $0.6 million. MSAF Group currently leases one B757-200 to National Airlines, which represents 1.6% of the portfolio by appraised value as of September 30, 2000. On December 6, 2000, National Airlines announced that it had voluntarily filed petitions in the U.S. District Court in Wilmington, Delaware for relief under Chapter 11 of the U.S. Bankruptcy Code. It is not yet clear whether National Airlines will raise the necessary financing to continue operations.
PACIFIC (DEVELOPED)
MSAF Group currently leases 13.1% of the portfolio by appraised value as of September 30, 2000 in the Pacific (Developed) region. As of February 1, 2001, none of these lessees were in arrears.
EUROPE AND MIDDLE EAST (EMERGING)
MSAF Group currently leases 7.7% of the portfolio by appraised value as of September 30, 2000 in the Europe and Middle East (Emerging) region. Three of the seven lessees in arrears are based in this region.
As of February 1, 2001, Air Alfa, a lessee based in Turkey, owed total arrears of $2.3 million, of which $1.7 million related to rental payments and $0.6 million related to maintenance reserves. MSAF Group held a security deposit of $0.7 million against these arrears. The lessee is unable to cure its payment defaults and as a result the Servicer has commenced repossession proceedings. This aircraft, an A321-100, represents 2.0% of the portfolio by appraised value as of September 30, 2000.
As of February 1, 2001, Travel Service, a lessee based in the Czech Republic, owed maintenance arrears of $0.2 million, against which MSAF Group held a security deposit of $0.5 million. This aircraft, a B737-400, represents 1.1% of the portfolio by appraised value as of September 30, 2000.
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As of February 1, 2001, Olympic Airways, a lessee based in the Greece, owed total arrears of $0.4 million, of which $0.3 million related to rental payments and $0.1 million related to maintenance reserves. MSAF Group held a security deposit of $0.5 million against these arrears. This aircraft, a B737-400, represents 1.3% of the portfolio by appraised value as of September 30, 2000.
ASIA (EMERGING)
MSAF Group currently leases 15.9% of the portfolio by appraised value as of September 30, 2000 in the Asia (Emerging) region. As of February 1, 2001, none of the lessees in this region were in arrears.
LATIN AMERICA (EMERGING)
MSAF Group currently leases 5.0% of the portfolio in Latin America (all in Mexico) by appraised value as of September 30, 2000. None of the lessees currently in arrears are based in Latin America. However, arrears that were categorized as Bad Debts during the Eight Month Period related to two aircraft that were leased in Latin America. See "Bad Debts" below and Section II (b)--"Comparison of Actual Cash Flows versus the 2000 Base Case for the Eight Month Period from April 2000 to November 2000", line items [6] and [7] for a discussion of these Bad Debts.
OTHER
MSAF Group currently leases 17.2% of the portfolio by appraised value as of September 30, 2000 in the Other region. One of the seven lessees currently in arrears is based in this region.
As of February 1, 2001, Air Atlanta Icelandic, a lessee based in Iceland, owed total arrears of $1.0 million, of which $0.5 million related to rental payment and $0.5 million related to maintenance reserves. MSAF Group held a security deposit of $0.5 million against these arrears. The aircraft, a B747-300, represents 2.2% of the portfolio by appraised value as of September 30, 2000.
BAD DEBTS
With the exception of the Current Arrears of $6.4 million that was discussed under Lessee Difficulties above, as of February 1, 2001 there were no other arrears amounts due to be paid to the MSAF Group.
During the Eight Month Period, rental arrears associated with two lessees, both based on Brazil, were deemed irrecoverable and classified as Bad Debts.
One of the lessees, B.R.A., defaulted on its obligations under its lease of an A310-300 and the aircraft was repossessed in May 2000. The lease was scheduled to expire in July 2007. Rental arrears, associated with the lessee, at the time of repossession amounted to $1.3 million and were re-classified from Current Arrears to Bad Debts during the Eight Month Period. There was no security deposit held by MSAF Group to offset against the arrears balance.
The second lessee, VASP, defaulted on its obligations under its lease of a B737-300 and the aircraft was repossessed in May 2000, following legal proceedings against VASP. The lease was scheduled to expire in March 2003. Rental arrears, associated with the lessee, at the time of repossession amounted to $0.5 million and were re-classified from Current Arrears to Bad Debts during the Eight Month Period. A security deposit of $0.7 million, held by MSAF Group, was drawn down against this lessee, covering the arrears and a portion of the expenditure incurred in returning the aircraft to a deliverable condition.
RESTRUCTURED ARREARS
A former Brazilian lessee, VARIG, negotiated an early termination of its lease of a B747-300 aircraft in July 1999. The total amount of rental payments and maintenance reserves due under this lease, at the date of the termination agreement, was $4.8 million against which MSAF Group drew down a security
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deposit of $1.1 million. Under the terms of the termination agreement, VARIG is scheduled to repay $10.8 million over eight years to offset arrears of $4.8 million and approximately $6.0 million for maintenance and downtime costs. Provided no default has occurred by October 2005 under this note payable, the total remaining payments will be reduced by approximately $1.1 million on a pro-rata basis between October 2005 and October 2007, the scheduled final payment date under the note. As of February 1, 2001, VARIG had made all payments due under the note payable. This aircraft represents approximately 2.2% of the portfolio by appraised value as of September 30, 2000.
In January 2000, TransAer, a lessee based in Ireland, restructured rental and maintenance arrears for two A320-200 aircraft into a note payable of $1.4 million. The terms of the restructuring agreement were that amounts totaling $1.4 million would be repaid during June, July and August 2000. None of these restructured arrears were paid. In October 2000, TransAer filed for bankruptcy, with total arrears outstanding of $1.6 million at that date. MSAF Group drew down security deposits of $1.0 million against these arrears. These aircraft, both A320-200s, represent 3.2% of the portfolio by appraised value as of September 30, 2000.
AIRWORTHINESS DIRECTIVE
The FAA issued an Airworthiness Directive (AD) in each of July and August 2000 requiring special detailed inspections to detect cracking of the main deck cargo door frames of Pemco-converted Boeing 737-200 and 737-300 freighters. The FAA is now considering a further AD to supersede the first two ADs, the result of which may be a requirement to replace the main deck cargo door frames. There are two aircraft in the portfolio, which may be subject to the findings of the FAA, together representing 2.0% of the portfolio by appraised value as of September 30, 2000. Under the lease of the first aircraft, all costs of compliance with ADs are the obligation of the lessee. Under the lease of the second aircraft, all costs of compliance of this potential AD are to be shared by lessor and lessee. The lessee of the second aircraft has completed all required changes in respect of this AD. The cost of the work was less than $50,000.
On September 14, 2000, the United States Federal Aviation Administration (FAA) announced a proposal for the long-term redesign of the Boeing 737 rudder system and several short-term initiatives designed to enhance rudder safety on all Boeing 737 models. The redesign would increase the overall safety of the B737 by simplifying the rudder system and eliminating a range of both previously known and recently discovered failure possibilities. It may be some time before the FAA issues a formal AD. There are currently twenty B737s in the portfolio, together representing 23.4% of the portfolio by appraised value as of September 30, 2000. One of the twenty B737 aircraft is currently off-lease, but under the remaining nineteen leases all costs of compliance with ADs are the obligation of the lessees.
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V APPENDICES
See attached sheets for details
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APPENDIX A
PORTFOLIO ANALYSIS AS OF FEBRUARY 1, 2001
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(1) Regions are defined according to the Morgan Stanley Capital International designations
(2) Aircraft has not yet been delivered to Cyrpus Airways
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APPENDIX B
COMPARISON OF ACTUAL CASH FLOWS VERSUS THE 1998 BASE CASE FOR DECEMBER 1999 TO MARCH 2000
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APPENDIX C
COMPARISON OF ACTUAL CASH FLOWS VERSUS THE 2000 BASE CASE FROM APRIL 2000 TO NOVEMBER 2000
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APPENDIX D
COVERAGE RATIOS AS OF NOVEMBER 15, 2000
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[1] INTEREST COVERAGE RATIO is equal to Net Cash Collections, before interest and swap payments, expressed as a ratio of the swap costs and interest payable on each subclass of Notes plus the interest and minimum principal payments payable on each subclass of Notes that rank senior in priority of payment to the relevant subclass of Notes.
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[2] DEBT COVERAGE RATIO is equal to Net Cash Collections before interest and swap payments, expressed as a ratio of the interest and minimum and scheduled principal payments payable on each subclass of Notes plus the interest and minimum and scheduled principal payments payable on each subclass of Notes that ranks equally with or senior to the relevant subclass of Notes in the priority of payments.
[3] ASSUMED PORTFOLIO VALUE represents the Initial Appraised Value of each aircraft in the Portfolio multiplied by the Depreciation Factor at Calculation date divided by the Depreciation Factor at Closing date.
[4] ADJUSTED PORTFOLIO VALUE represents the Base Value of each aircraft in the Portfolio as determined by the most recent Appraisal multiplied by the Depreciation Factor at Calculation Date divided by the Depreciation Factor ar Closing Date. The lower of the Assumed Portfolio Value or 105% of the Adjusted Portfolio Value is used to calculate the principal repayment amounts to Noteholders.
[5] TOTAL ASSET VALUE is equal to Total Portfolio Value plus Liquidity Reserve Amount.
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EXHIBIT INDEX
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* Previously filed on Registration Statement on Form S-4 (File No. 333-56575) with the Securities and Exchange Commission.
** Previously filed on Registration Statement on Form S-1 (File No. 333-56575) with the Securities and Exchange Commission.
*** Filed herewith.