AIG 2005 Annual Report Download - page 104

Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
Retirement Services businesses purchased a large share of the
Aircraft Finance securities issued in connection with these securitizations, which
AIG’s Aircraft Finance operations represent the operations of included both debt and equity securities.
ILFC, which generates its revenues primarily from leasing new Management formally reviews regularly, and no less fre-
and used commercial jet aircraft to domestic and foreign quently than quarterly, issues affecting ILFC’s fleet, including
airlines. Revenues also result from the remarketing of commer- events and circumstances that may cause impairment of aircraft
cial jets for its own account, for airlines and for financial values. Management evaluates aircraft in the fleet as necessary,
institutions. based on these events and circumstances in accordance with
ILFC finances its purchases of aircraft primarily through the Statement of Financial Accounting Standards No. 144 —
issuance of a variety of debt instruments. The composite ‘‘Accounting for the Impairment or Disposal of Long-Lived
borrowing rates at December 31, 2005, 2004 and 2003 were Assets’’ (FAS 144). ILFC has not recognized any impairment
5.00 percent, 4.34 percent and 4.53 percent, respectively. See related to its fleet, as the existing service potential of the
also the discussions under ‘‘Capital Resources’’ and ‘‘Liquidity’’ aircraft in ILFC’s portfolio has not been diminished. Further,
herein and Notes 2 and 9 of Notes to Consolidated Financial ILFC has been able to re-lease the aircraft without diminution
Statements. in lease rates to an extent that would require an impairment
ILFC’s sources of revenue are principally from scheduled write-down. See also the discussions under ‘‘Liquidity’’ herein.
and charter airlines and companies associated with the airline
industry. The airline industry is sensitive to changes in Capital Markets
economic conditions, cyclical and highly competitive. Airlines
Capital Markets represents the operations of AIGFP, which
and related companies may be affected by political or
engages in a wide variety of financial transactions, including
economic instability, terrorist activities, changes in national
standard and customized interest rate, currency, equity, com-
policy, competitive pressures on certain air carriers, fuel prices
modity and credit products and structured borrowings through
and shortages, labor stoppages, insurance costs, recessions, and
notes, bonds and guaranteed investment agreements. AIGFP
other political or economic events adversely affecting world or
also engages in various commodity and foreign exchange
regional trading markets. ILFC’s revenues and income will be
trading, and market-making activities.
affected by its customers’ ability to react and cope with the
As Capital Markets is a transaction-oriented operation,
volatile competitive environment in which they operate, as
current and past revenues and operating results may not
well as ILFC’s own competitive environment.
provide a basis for predicting future performance. Also, AIG’s
ILFC is exposed to operating loss and liquidity strain
Capital Markets operations may be adversely affected by the
through nonperformance of aircraft lessees, through owning
downgrades in AIG’s credit ratings. See ‘‘Risk Factors — AIG’s
aircraft which it would be unable to sell or re-lease at
Credit Ratings,’’ in Item 1A. Risk Factors for a further
acceptable rates at lease expiration and, in part, through
discussion of the potential effect of the rating downgrades on
committing to purchase aircraft which it would be unable to
AIG’s Capital Markets businesses.
lease.
AIG’s Capital Markets operations derive substantially all
ILFC manages the risk of nonperformance by its lessees with
their revenues from hedged financial positions entered in
security deposit requirements, through repossession rights,
connection with counterparty transactions rather than from
overhaul requirements, and closely monitoring industry condi-
speculative transactions. AIGFP participates in the derivatives
tions through its marketing force. However, there can be no
and financial transactions dealer markets conducting, primarily
assurance that ILFC would be able to successfully manage the
as principal, an interest rate, currency, equity, commodity,
risks relating to the effect of possible future deterioration in
energy and credit products business.
the airline industry. Approximately 90 percent of ILFC’s fleet
As a dealer in financial derivatives, AIGFP marks all
is leased to non-U.S. carriers, and this fleet, comprised of the
derivative and trading transactions to fair value daily. Thus, a
most efficient aircraft in the airline industry, continues to be in
gain or loss on each transaction is recognized daily. Under
high demand from such carriers.
GAAP, in certain instances, gains and losses are required to be
ILFC typically contracts to re-lease aircraft before the end
recorded in earnings immediately, whereas in other instances,
of the existing lease term. For aircraft returned before the end
they are required to be recognized over the life of the
of the lease term, ILFC has generally been able to re-lease such
underlying instruments. AIGFP economically hedges the mar-
aircraft within two to six months of its return. As a lessor,
ket risks arising from its transactions, although hedge account-
ILFC considers an aircraft ‘‘idle’’ or ‘‘off lease’’ when the
ing is not currently being applied to any of the derivatives and
aircraft is not subject to a signed lease agreement or signed
related assets and liabilities. Accordingly, revenues and operat-
letter of intent. ILFC had no aircraft off lease at December 31,
ing income are exposed to volatility resulting from differences
2005. As of March 10, 2006, all new aircraft deliveries in 2006
in the timing of revenue recognition between the derivatives
have been leased, and 76 percent of 2007 new aircraft
and the hedged assets and liabilities. Revenues and operating
deliveries have been leased. See also the discussions under
income of the Capital Markets operations and the percentage
‘‘Capital Resources’’ and ‘‘Liquidity’’ herein.
change in these amounts for any given period are also
ILFC sold two portfolios consisting of 34 and 37 aircraft in
significantly affected by the number, size and profitability of
2004 and 2003, respectively, to two trusts connected to
transactions entered into by these subsidiaries during that
securitization transactions. Certain of AIG’s Life Insurance &
52 AIG m Form 10-K