2007 Annual Report - AIG.com

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
In order to better align financial reporting with the manner in
which AIG’s chief operating decision makers manage their businesses,
beginning in 2007, net realized capital gains and losses,
including derivative gains and losses and foreign exchange
transaction gains and losses for Financial Services entities other
than AIGFP, which were historically reported as a component of
AIG’s Other category, are now reported in Financial Services
revenues and operating income. Prior period amounts have been
revised to conform to the current presentation.
2006 and 2005 Comparison
Financial Services operating income decreased in 2006 compared
to 2005, due primarily to the effect of hedging activities that did
not qualify for hedge accounting treatment under FAS 133.
Aircraft Leasing
ILFC’s operating income decreased in 2006 compared to 2005.
Rental revenues increased by $536 million or 16 percent, driven
by a larger aircraft fleet, increased utilization and higher lease
rates. During 2006, ILFC’s fleet subject to operating leases
increased by 78 airplanes to a total of 824. The increase in rental
revenues was offset in part by increases in depreciation expense
and interest expense, charges related to bankrupt airlines, as well
as the settlement of a tax dispute in Australia related to the
restructuring of ownership of aircraft. Depreciation expense in-
creased by $200 million, or 14 percent, in line with the increase
in the size of the aircraft fleet. Interest expense increased by
$317 million, or 28 percent, driven by rising cost of funds, a
weaker U.S. dollar against the Euro and the British Pound and
additional borrowings funding aircraft purchases. As noted above,
ILFC’s interest expense did not reflect the benefit of hedging
these exposures. In 2006 and 2005, the effect from hedging
activities that did not qualify for hedge accounting treatment under
FAS 133, including the related foreign exchange gains and losses,
was a $73 million loss and a $93 million gain, respectively, in
both revenues and operating income.
Aircraft Leasing operations represent the operations of ILFC, which
generates its revenues primarily from leasing new and used
commercial jet aircraft to foreign and domestic airlines. Revenues
also result from the remarketing of commercial aircraft for ILFC’s own
account, and remarketing and fleet management services for airlines
and financial institutions. ILFC finances its aircraft purchases
primarily through the issuance of debt instruments. ILFC economically
hedges part of its floating rate and substantially all of its foreign
currency denominated debt using interest rate and foreign currency
derivatives. Starting in the second quarter of 2007, ILFC began
applying hedge accounting to most of its derivatives. All of ILFC’s
derivatives are effective economic hedges; however, since hedge
accounting under FAS 133 was not applied prior to April 2, 2007, the
benefits of using derivatives to hedge these exposures are not
reflected in ILFC’s 2006 corporate borrowing rate. The composite
borrowing rates at December 31, 2007 and 2006 were 5.16 percent
and 5.17 percent, respectively.
ILFC typically contracts to re-lease aircraft before the end of
the existing lease term. For aircraft returned before the end of the
lease term, ILFC has generally been able to re-lease such aircraft
within two to six months of their return. As a lessor, ILFC
considers an aircraft ‘‘idle’’ or ‘‘off lease’’ when the aircraft is not
subject to a signed lease agreement or signed letter of intent.
ILFC had no aircraft off lease at December 31, 2007, and all new
aircraft scheduled for delivery through 2008 have been leased.
Aircraft Leasing Results
2007 and 2006 Comparison
ILFC’s operating income increased in 2007 compared to 2006.
Rental revenues increased by $596 million or 15 percent, driven
by a larger aircraft fleet and higher lease rates. As of Decem-
ber 31, 2007, 900 aircraft in ILFC’s fleet were subject to
operating leases compared to 824 aircraft as of December 31,
2006. During 2007, ILFC realized income of $31 million from the
sale of its rights against bankrupt airlines. The increase in
revenues was partially offset by reduced flight equipment market-
ing revenues and increases in depreciation and interest expense.
Flight equipment marketing revenues decreased by $40 million
compared to 2006 due to fewer aircraft sales. Depreciation
expense increased by $166 million, or 11 percent, in line with the
increase in the size of the aircraft fleet. Interest expense
increased by $176 million, or 12 percent, driven by additional
borrowings to fund aircraft purchases and the rising cost of funds.
In 2007 and 2006, the losses from hedging activities that did not
qualify for hedge accounting treatment under FAS 133, including
the related foreign exchange gains and losses, were $37 million
and $73 million, respectively, in both revenues and operating
income. During 2006, ILFC recorded charges to income related to
a tax settlement in Australia, increased credit reserves and
increased lease accruals, all of which totaled $37 million.
2006 and 2005 Comparison
Capital Markets
Capital Markets represents the operations of AIGFP, which
engages as principal in a wide variety of financial transactions,
including standard and customized financial products involving
commodities, credit, currencies, energy, equities and rates. The
credit products include credit protection written through credit
default swaps on super senior risk tranches of diversified pools of
loans and debt securities. AIGFP also invests in a diversified
portfolio of securities and principal investments and engages in
borrowing activities involving the issuance of standard and
structured notes and other securities, and entering into guaranteed
investment agreements (GIAs).
As Capital Markets is a transaction-oriented operation, current
and past revenues and operating results may not provide a basis
for predicting future performance. AIG’s Capital Markets opera-
tions derive a significant portion of their revenues from hedged
financial positions entered into in connection with counterparty
transactions. AIGFP also participates as a dealer in a wide variety
of financial derivatives transactions. Revenues and operating
82 AIG 2007 Form 10-K