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Aircastle Limited (NYSE:AYR)

Q3 2012 Earnings Conference Call

November 6, 2012 10:00 AM ET

Executives

Frank Constantinople – Senior Vice President, Investor Relations

Ron Wainshal – Chief Executive Officer

Mike Inglese – Chief Financial Officer

Analysts

Gary Liebowitz - Wells Fargo Securities

John Godyn - Morgan Stanley

Ray Neidl - Maxim Group

Helane Becker - Dahlman Rose

Isaac Husseini - Barclays Capital

Jamie Baker - JP Morgan

Justine Fisher - Goldman Sachs

Scott Valentin - FBR Capital Markets

Andrew Light - Citigroup

Glenn Engel - Bank of America/Merrill Lynch

Operator

Good day and welcome to the third quarter of 2012 Aircastle Limited Earnings Conference Call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Frank Constantinople. Please go ahead, sir.

Frank Constantinople

Thank you, Shannon. Good morning everyone. I’m Frank Constantinople, Senior Vice President of Investor Relations, and I’d like to welcome all of you to Aircastle Limited’s third quarter 2012 earnings call.

With me today are Ron Wainshal, Aircastle’s Chief Executive Officer; and Mike Inglese, our CFO.

We will begin the presentation shortly but I would like to mention that the call is being recorded and the replay number is 888-203-1112 from within the United States and Canada, from outside of the U.S. and Canada the number is 719-457-0820. The replay passcode for this call is 8983455. This call will also be available via webcast on our website at www.aircastle.com along with the earnings press release and PowerPoint presentation.

I would like to point out that statements today, which are not historical facts, may be deemed forward-looking statements. Actual results may differ materially from these estimates or expectations expressed in those statements and certain facts that could cause actual results to differ materially from Aircastle Limited’s expectations are detailed in our SEC filing which can also be found on our website. I’ll direct you to Aircastle Limited’s earnings release for the full forward-looking statement legend.

And I’ll now turn the call over to Ron.

Ron Wainshal

Thanks Frank, we appreciate everyone joining our call today. During my remarks I’ll touch on the business environment, our annual fleet review, Aircastle’s performance during the third quarter the company’s plan going forward. Mike Inglese will follow with a review of our financial results and then we’ll open the call for questions.

We delivered very good operating results during the third quarter of 2012 despite a tough business environment. Our cash flows were strong driven by portfolio growth and a fleet utilization rate of 99%. In addition, we continued to execute on our acquisition strategy and make a creed of new investments. From a strategic standpoint, now is a very good time for Aircastle. Asset prices are attractive and capital markets debt costs are low. It is unusual for these two dynamics to occur at the same time. Our access to the capital markets for unsecured debt continues to be a powerful tool and we’re enhancing our standing in the debt market by building our unencumbered asset base which now include 70 aircraft with a net book value of $2 billion.

In terms of deploying capital, we continue to take a balanced approach. Our focus is on growing profitably, increasing our operating cash flows and returning capital to shareholders with dividend increases. Our decision to raise dividend by 10% which is the third increase since the beginning of 2011 reflects growth and the company’s earnings power and cash flow over the past year. It also reflects our board’s optimism about Aircastle’s long term prospects.

During third quarter, we also re-purchased from our founding shareholder the remaining shares in Aircastle for $28.5 million. Since the spring of 2011, we’ve returned $119 million to shareholders via stock buybacks. We continue to believe our shares are undervalued and as a result we just increased our share buyback program again to $50 million.

In our view, buying shares at current market levels provides good long term dive[ph] for shareholders. I’ll now touch on the business environment. The long term outlook for aircraft leasing remains positive. The world’s commercial aircraft fleet continues to grow and less order so an increasing share of it. We believe major shifts in the financing marketing including the client traditional aerospace bank capacity and more expensive expert credit support will drive more business to leasing companies. In other words, we see aircraft leasing companies playing an even bigger role, serving as a bridge to financial markets for airlines. However, the macro-economic environment has been weak this year as the global economy has slowed.

Growth in air travel and global GDP are closely linked, and in our view slowing world economy will inevitably lead to reduced space or air traffic expansion. However, the most recent international air transport association data was surprisingly strong on the passenger side. During September, passenger air traffic increased 4.1% versus a year ago. This is lower than the year-to-date rate of 5.7%, but still very respectable in light of the economic environment. The picture on the freight side is clearly weaker and has been for the past year and a half. I IATA’s freight statistics for September, showed a small increase of 0.6% versus last year’s relatively weak level of traffic. We are in the midst of the busy season for air cargo, but not seeing much recovery although a few new hightech product introductions will help a bit. There is certainly also re-allocation of flying going on with the big three gulf carriers Emirates, Etihad and Qatar picking up market share just as they are in the long call passenger market.

On the supply side, we continue to be concerned about increased production at a time when demand growth is slowing. This puts pressure on rentals and has pushed an increasing number of modern aircraft into storage particularly narrow bodies and long-haul freighters. The number of part A320 family aircraft with latest engines continues to grow and is now at the same level two years ago and has had an even higher level than 2009. Fortunately, we only have two of these A320s to place over the next 12 months.

Earlier technology models like the 737 classics and A320s with over-generation engines are becoming increasingly marginalized. We are seeing very high levels of storage aircraft to these types. However, these models represent only 1.3% of our fleet by net book value and we have been gradually disposing them.

Lower business and consumer confidence is the key driver in explaining diminished demand for leased aircraft. This is a big deal for airlines operating wide bodies, given the more substantial investments and operating costs involved in comparison narrow bodies. Rents for 777 and to a lesser extent new A330s have remained relatively firm. However, 767s have been particularly hard hit by the slower confidence levels. Even though parked aircraft levels for 767s are modest in comparison with older narrow body models. On the other hand, 767 should have a better chance of rebounding, should conditions improve. Nonetheless, as I’ll discuss in a moment, we have made adjustments to carrying values, useful lives and residual values for 767 fleet reflecting market conditions and our current expectations for future cash flows for these aircraft.

We recently completed our annual fleet review. Due to this process, we updated our business plan and cash flow projections for each aircraft in our fleet. The Aircastle were big enough to have an excellent market advantage point, get small enough to carefully evaluate our aircraft individually.

In general, we believe our fleets are performing well. In our view, the value of our fleet is well in excess about suggested by our stock market capitalization. We are particularly pleased with the success of our investment program over the past three years. Nonetheless we are focusing on improving returns on capital and continue to make smart investment decisions based on a realistic assessment of future cash flows for each airplane.

As we evaluated current market conditions and our cash flow projections we recorded non-cash impairment charges related to 10 older generation narrow bodies or 767 300ERs and an A310 freighter. These charges totaled $78.79 million or approximately 1.7% of our fleet’s net book value. All the aircrafts involved are older technology models, their average age is 21 years. There are few newer, but last off the line in 737 400s. Simply put these are all older airplanes that are generally getting towards the end of their economic lives, having said that only one of these is currently off lease. So, the aircrafts are not operationally obsolete. There has been a great deal of market commentary recently about useful lives and residual values as there tends to be during more challenging economic circumstances.

We believe, two important distinctions have been lost in the discussion of these accounting measures. Number one, useful life and residual value estimate, the rough approximation is done on a fairly generic basis often early in an aircraft’s life. These estimates are not supposed to be skewed either too high or too low. We and other lessors must reassess these estimates periodically and if such – some levels of impairment is to be expected overtime particularly during busing slowdowns. Likewise, residual turnouts to be conservative or market conditions robust, sales will generate gains as we’ve seen on numerous instances.

Secondly, we believe that the useful life of an aircraft will be driven in large parts by works dated manufacture falls in the production life of the platform. The aircraft produced towards the end of the production run will likely have shorter lives. It is not just an aircraft’s age that matters. This has been born out in our philosophy and it is an element in our investment program. As an investor we are focused on the capital efficiency of our assets and whether it is makes sense financially to continue re-investing in an aircraft or disposing it no matter it’s age or soon residual value for book purposes. For example, we negotiated an early lease termination with a customer in Turkey for two 21-year-old A320s with older generation engines. Even if the aircraft is still 4 years shy of their 25th birthdays. All four engines reduced (inaudible) imminently and re-investing the cash maintenance reserves would help, made no economic sense. So, we impaired these aircrafts in Q3 upon entering into an early termination agreement for the lease and recorded around $11 million in maintenance revenue.

We expect to complete the part-out of sale of these aircraft in Q4 for an amount roughly equal to the reduced net book value. Mike will provide more details about our fleet analysis and it’s accounting implications.

Now, let’s turn to our performance in Q3, 2012. Strong lease revenue growth drove our operating results in Q3. We reported operating and finance lease rental revenue of $163 million versus $146 million in Q3 2011, a 12% increase. Excluding our non-cash impairment charges for the third quarter we generated net income of $32.8 million or $0.47 per diluted share. An adjusted net income was $41.2 million or $0.59 per diluted share. For the first time nine months of 2012, cash flow from operations before working capital changes was over $300 million, that compares to $265 million in the year earlier. We believe these are very good results, they reflect positive contributions from our new investments as well as strong portfolio performance evidenced by our 99% fleet utilization and 14% rental yield.

Regarding new investment, we acquired 4737-800 aircraft during the quarter for approximately $120 million that brings total investments in 2012 through September 30 to about $610 million. An additional $170 million of investments closed or is expected to close during the fourth quarter including our first (inaudible) acquisitions. More specifically to E195s which are in long term leases to (inaudible) in Brazil. It is worth noting that a majority of our investments this year have involved aircraft lease to Asian carriers. This is one of the reasons lease rental revenues from carriers in this region increased to one third of the total during the third quarter versus a quarter a year ago.

Turning the aircraft placements, we’ve been very active in addressing 30 aircrafts coming off lease this year, 25 of these have been replaced or sold and an another subject to a lease letter of intent, there are at least four to go with a net book value of 2.5% of our total fleet. The remaining four aircraft of this year consist of 2747-400 freighters of southern which is undergoing a chapter 11 restructuring. Additionally, there is 1767-300 ER and an A320. In addition to the 17 aircraft was scheduled lease expirations this year, obviously we also addressed few other situations, this included airline restructuring as well as transactions where we sought to work with our customers to meet their business objectives on a mutually beneficial basis. For example, we agreed to early terminate 1747-400 freight release that had been with Martinair, one of our largest customers. In exchange, they agreed to extend the lease on one MD-11 freighter that had been set to expire in January of next year. This arrangement allowed the airline to downsize it’s cargo capacity for providing us with a long term lease arrangement for an aircraft that is more difficult to place in the current environment. Recently, we signed the lease with a leading ACMI provider for the 747-400 freighter exiting the Martinair fleet. This transaction was a win-win for both Aircastle and our customer. It also demonstrated our freighter placement capabilities even in the phase of weak air cargo market.

For 2013, we had 18 aircrafts scheduled to come off lease during the year. The net book value of these aircraft is only about 6% of our total fleet leaving us with a relatively modest exposure what we believe will be a relatively challenging year for placement. Nonetheless, we’ve been making progress in reducing this list. Looking ahead, we believe we’re poised to continue carrying strong operating results. Our portfolio is comprised of while these aircraft to be still large and diverse customer base and has an average remaining lease term of almost 5 years. In addition, Aircastle has a strong team and is well positioned from a financing standpoint. We have a good cash position, no remaining aircraft orders, and no refinancing needs until 2017.

Capital markets conditions are currently very attractive and we believe our access to the unsecured debt market is a strategic advantage. This is a good time to grow. There are a lot of transactions in the market today and we are optimistic about deal flow. However, the extent to which seller price expectations match up with those of our own and other buyers remains unclear. We’re going to be disciplined, patient and look to the origination strengths of our team. In that regard, I’ll note that we have built our portfolio over time to 91 transactions with 62 counter parties providing us with a broad range of market contacts.

We are going to continue focusing on areas where we feel there is good value and where we believe that we have a competitive edge. These situations include purchases of higher quality new wide-bodies which we expect to account for about half of our new investment volume this year. We also see great value in mid-age aircraft where competition is lower and the payback to part-out period is relatively short. We’ll also continue to keep our eyes open for other situations that offer compelling risk adjusted returns. While we sold more than half a billion dollars of assets for gain of nearly $40 million last year. We expect aircraft sales will play a much more modest role this year and next given the weakness in asset prices.

In general, we think this is the better time to buy than sell. However, we’ll continue to explore opportunities to increase the capital efficiency of our fleet particularly for aircraft that are older. We’re also continuing to review engine sharpness as rigorously given the rising cost and at the same time the downward pressures on the engine prices. In short, I am very bullish about our ability to grow profitably, thanks to the favorable investment climate and the attractive capital market conditions. This should allow us to drive enhanced economic performance for Aircastle even in softer markets and again our philosophy is to sharing the company’s growth through increases in our dividend over time.

I’ll now turn the call over to Mike.

Mike Inglese

Thanks Ron. During the third quarter, the investments that we made towards the end of last year and through the first nine months of 2012 have led to solid topline growth and continued strong cash flow from operations. Regarding third quarter results, our lease/rental revenue was $159.5 million, an increase of 9% primarily due to the net impact of aircraft acquisitions made over the last 12 months. Including finance lease income, leased rental revenue rose 12% to $163.1 million. Total revenues were a $172.9 million, an increase of $31.4 million or 22% over the prior year period, primarily driven by higher lease rental revenues, higher maintenance revenues, partially offset by higher amortization of lease incentives and lease premiums in the quarter.

During the third quarter, we acquired four 737-800 aircraft on lease to an Asia carrier and as Ron mentioned this brings year-to-date aircraft acquisition total to about $610 million and we have another 170 that has closed or is expected to close during the fourth quarter.

Other revenues for the quarter were $9.2 million which consist of interest income on finance leases of about $3.5 million, dead investments of $1.3 million also during the third quarter we recorded $3.9 million in early lease termination fees. Adjusted EBITDA which excluded the impairment charge was $166.3 million up 18% over the prior year’s quarter. This increase was driven by lease rental revenues of $13.7 million, higher maintenance and other revenues of $19.8 million which were partially offset by lower gains on sale of $9 million. As Ron mentioned, we performed our annual recoverability assessment in conjunction with our fleet review during the third quarter and determined that the estimated future cash flows is certain of our aircraft did not support the carrying values. Specifically, we have observed weak market demand for all the technology narrow bodies certain mid bodies based on slowing global economic growth rates, declining business confidence levels and higher fuel prices.

As a result, we recorded impairment charges of $67.4 million on 737 classics, four 767-300ERs and A310 freighter. To write the value of these aircrafts down to their estimated current market value. In addition, as part of recoverability assessment we considered the usable life and residual value of each aircraft in our portfolio and as a result for 7 other aircraft that has the recoverability assessment in addition to the aircraft that we impaired, we shortened the estimated lives and reduced residual values for those aircrafts. These changes in estimated lives and residual values across all 22 aircrafts, the 15 that were impaired as well as the other 7 will result in very modest uptick in depreciation run rate in 2013 of about $2 million and finally based on pure cash economics, we made the decision not to invest additional capital in two A320 200 classics and instead entered into an early lease termination agreement. We expect to part these aircraft out during the fourth quarter for their reduced carrying value. As a result of these terminations, these aircrafts fail the recoverability assessment and recorded impairment charges of $11.3 million across these two aircrafts. These charges are offset by $10.2 million of associated maintenance revenue and $1.2 million recognition of lease incentive benefits, both of which were recorded during the third quarter.

Our adjusted net loss for the second quarter was $37.5 million or $0.53 per diluted share compared to adjusted net income of $26 million or $0.35 per share in third quarter of 2011. The year-over-year decrease is largely attributable to the total $78.7 million impairment charge taken during the quarter versus $1.2 million in 2011, lower gains associated with aircraft sales activity and $8.2 million of higher depreciation expense associated with aircraft required over the last 12 months. A $31.4 million increase in total revenues partially offset these increase expense items. Excluding the impairment charge, adjusted net income was $41.2 million or $0.59 per diluted share for the quarter.

Interest expense net for the quarter was $54.1 million, an increase of $5.2 million over the prior year. The change is primarily due to an increase of $4.1 million related to higher average debt outstanding, higher non-cash hedging effectiveness and hedge loss amortization totaling $4.8 million and $1.7 million of lower capitalized interest. Partially offsetting these items was a decrease of $4.8 million due to lower weighted average interest rate on our borrowings, primarily driven by the effectiveness of our securitization number to interest rate swaps, which became effective during late second quarter of this year.

Adjusted net income, which adds back the hedging effectiveness of the Term Financing Number 1 amortization and after the impact of our adjusted interest expense for Q3 was about $1 million higher versus third quarter of 2011. SG&A was roughly flat versus last year while depreciation expense for the third quarter was $68.4 million versus $60.1 million for 2011. The increase in depreciation is primarily related to the growth in the fleet on a year-over-year basis.

Tax provision for the third quarter was $1.7 million, which is approximately 5% of pre-tax income, excluding the impairment charge in the quarter. We expect the effective tax rate for the fourth quarter to remain in the 7% to 8% range, excluding the impact of the year-to-date impairment charge. At the end of the quarter, we owned 157 aircraft, with an annualized lease rental run rate including finance leases of about $631 million, of which $274 million is associated with our 70 unencumbered aircraft.

For the nine months ended September 30th, our cash flow from operations before working capital changes was $301.4 million, up 14% compared to the $264.8 million for the prior period. Our unencumbered aircraft had a net book value of approximately $2 billion or roughly 43% of the net book value of our total aircraft portfolio.

We continue to actively manage the portfolio and sold one aircraft during the quarter and for year-to-date. Our year-to-date gain on sale was approximately $3.1 million. We disposed the Boeing 767-300, two 737 Classic and one 757-200. The $3.1 million of year-to-date gains from aircraft sales compares to $29 million for the first nine months of 2011. We are value investors, as Ron mentioned, and since our formation, we have sold over 35 aircraft for gross proceeds of just over $900 million and have generated an overall unlevered cash-on-cash IRR of 13.6% from the aircraft sold. As we continue forward, we will focus on the cash flow base economics of these investment and re-investment decisions.

Turning to the capital structure, at the end of the third quarter, our unrestricted cash balance totaled $224 million and we had restricted cash of $109 million. We have $50 million of availability under our unsecured revolving credit facility, with secured and unsecured borrowings totaling approximately $3.1 billion. Net debt of $2.9 billion is approximately 61% of the net book value of our flight equipment.

The ratio of secured debt to total debt at quarter-end was about 59%, down from about 85% at year-end 2011. Our net debt to equity ratio excluding the mark-to-market on our interest rate derivative was approximately 1.9 times. As a reminder, we have no asset coverage test in our unsecured bond indentures, no LTV test in any of our secured financing, and we are in compliance with all applicable covenants in all of our debt facilities at the end of the quarter.

Finally, turning to fourth quarter guidance on selected elements, we expect lease rental revenues of $152 million to $154 million and finance lease income of approximately $4 million. Maintenance revenues are estimated to be $14 million to $16 million, amortization of net lease premiums and lease incentives of $7 million to $9 million, SG&A is expected to be between $11 million to $12 million, consistent with our recent run rate, and depreciation of $69 million to $71 million.

Finally, interest net of $52 million to $55 million, including $4.4 million of hedge loss amortization relating to the refinancing of Term Financing Number 1 in the spring of this year. We remain confident that Aircastle is well positioned from the perspective of portfolio of strength, operating cash flow performance, capital structure and capital markets access as we enter the back end of this year. We expect our proven access to capital and strong cash position will enable us to take advantage and continuing investment opportunities that are consistent with our return to oriented focus.

And with that, operator, we are happy to open up the call for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And it does look like we have our first question from Mr. Gary Liebowitz with Wells Fargo Securities.

Gary Liebowitz - Wells Fargo Securities

Thank you operator and good morning gentlemen.

Ron Wainshal

Hi Gary.

Gary Liebowitz - Wells Fargo Securities

Ron, I was a little surprised that the impairment charge that you booked did not include any of the 747 freighters, especially given your comments earlier about the conditions in the freight market and the new supply coming online. Is this something that we need to be concerned with possible future impairments as you place the – as you try to market the Southern airplanes or do you think this is into the impairments for a while?

Ron Wainshal

Just a note on what the impairments represent, they represent a comparison of the future cash flows, the particular aircraft compared to its carrying value. For some aircraft, particularly the ones we impaired, we didn’t see a particularly long remaining life. For the freighters, we feel pretty confident about those aircraft flying around for a while, number one. Number two, obviously, we feel pretty good about the relationship of the rental levels versus the carrying value. Now, as it relates to Southern, yes, that’s a path we have to address. We did it earlier this year with the airplanes coming out of the world bankruptcy. And as I mentioned during my remarks, we just placed a 747-400 that was early terminated as part of a consensual agreement with Martinair. The market, it’s not strong as it used be, but let me remind you, the rental levels there were pretty strong year, year-and-a-half ago, and as you look at an aircraft that has a good utility, good remaining life, there is a possibility for better times ahead.

So, we are managing through this as we have in the past, and I am still pretty confident about the 747s.

Gary Liebowitz - Wells Fargo Securities

Okay. And then just one follow-up. Ron, given your comments on the target-rich environment for the types of assets that you prefer and your comments about the capital markets, I know you are not giving any formal outyear guidance, but should we think of the $800 million or so that you are acquiring in 2012 as sort of the baseline for the 2013?

Ron Wainshal

I think that’s a reasonable number to forecast out for the next 12 months, Gary.

Gary Liebowitz - Wells Fargo Securities

Okay. Thank you very much.

Ron Wainshal

Sure, thank you.

Operator

Our next question is from John Godyn with Morgan Stanley.

Ron Wainshal

Hi John.

John Godyn - Morgan Stanley

Hi guys. Thank you for taking my question here. Ron, you made a comment that we have heard before about sort of tighter general financing conditions driving more activity towards the lessors. I feel like we haven’t seen a flood activity yet, but are you seeing something change on the margin as we get close to 2013, when somebody’s financing requirements kick in, are you actually securing from customers more on the margin?

Ron Wainshal

Well, I think there are two different parts to your question, if I understood it right, John. One part of it probably relates to the higher ETA cost regime that kicks in, in January. Is that right?

John Godyn - Morgan Stanley

Yes.

Ron Wainshal

Well, we have seen a flood to the Ex-Im and ECA markets over the last several months, and it’s pretty obvious why. I mean, it’s just the last opportunity to kick to use the lower cost regime. The guarantee fees that borrowers have to pay for these guarantees from U.S. Ex-Im Bank in one case for Boeing aircraft or for the European ECAs. On the Airbus aircraft, we are more than double on January. And so, that I think is a good thing for anybody who is a commercial financier.

So, we are looking to a little bit more business in that respect and I am sure our peers are as well. The other thing that I wanted to touch on was, was not related to the ECAs, but the lower level of transaction activity in the secondary market. In 2012, we are actually so far at the all-time lows in terms of secondary market transaction activity. And the reason for that is two-fold. Number one, there is really no commercial bank debt available for used aircraft on meaningful quantity basis.

That puts into context the value of our unsecured debt. The other part of it is that we and other buyers that are prepared to move here are being disciplined about it. There are a lot of people with book value problems, a lot of people who are awaiting for better times, and I think that field flow will pick up as the next few months roll around.

John Godyn - Morgan Stanley

Okay. But I guess what I am getting at is, are you getting those indications of interest already or is this sort of a bet on the future?

Ron Wainshal

There is a larger amount of RFP activity in regards to sale leaseback for 2013 aircraft, number one. We are focusing on the wide-bodies, I think we will leave the narrow-bodies to the investors who sparkles and rise about the residual values for those aircraft. So, that’s already happening, but I think there is a lot of (inaudible).

John Godyn - Morgan Stanley

Okay. And you made another interesting comment in your prepared remarks about the A320s and how the parked aircraft were climbing and how you don’t have too much exposure there. It sounds like that’s a trend that you think is going to continue. Can you just kind of elaborate on your view on A320s as we look out the next few years? How much of sort of a structural headwind just there on aircraft type in supply demand?

Ron Wainshal

The first thing to notice that demand here is driven by the overall economy. If there is a pickup in the economy, I think that benefits A320s, 737s, all the aircraft. So, I think you are seeing a pickup in the parked level of A320 activity because, number one, demand is down, number two, production of the 320 family happened earlier than the 737s. 737s are not immune from this issue either, and then the third issue is that there have been a number of A320 oriented carriers that had financial hardships and that affects the parked supply as well. I think the bigger thing though is just to come back to the first point is that, it’s the slower rate of growth, and I think if there is a pickup, it’s going to be as much of an issue, but we have reflected our investment philosophy into away from those narrow-bodies and more into situations where we consider way to part that value.

John Godyn - Morgan Stanley

Okay. And could you update us on credit risk outside Southern, what are you seeing out there, has anything changed?

Ron Wainshal

Look, I think our receivable levels are in pretty good shape right now. We have a little bit of money tied up in the Southern bankruptcy as well as the world bankruptcy from earlier this year, but otherwise our levels are pretty modest. However, we are heading into traditionally the slower season where cash flow gets tighter for airlines. I think the weak points right now are among the less well-capitalized freighter airlines that are sort of dealing with persistently tougher environment for a while, and I think smaller carriers in more challenged jurisdictions I think is the other way to kind of categorize it. I wouldn’t say that there is any real big exposures that we are imminently afraid of, but it’s going to require a lot of diligence and hard work like just as we had in the last few winters.

John Godyn - Morgan Stanley

Okay. That’s helpful. And just last question really quick, of course, I know it’s a global market. But do you get any sense there – a certain amount of pent-up activity that could become unlocked after the presidential election? I just thought it would be timely question, I just want your thoughts there. Thanks.

Ron Wainshal

John, I don’t. Most of our business is outside of the U.S. There is kind of a fuzzy, general concern that kind of transmits around the world, but I think it’s most pronounced here obviously. It will have the more pronounced effect on the stock market and on the capital markets here in the U.S. I don’t think whether Romney or Obama are elected is going to change lease demand halfway around the world.

John Godyn - Morgan Stanley

Perfect. Thanks a lot, guys.

Ron Wainshal

Thanks John, and don’t forget to vote.

Operator

Our next question is from Ray Neidl with Maxim Group.

Ray Neidl - Maxim Group

Good morning.

Ron Wainshal

Good morning, Ray.

Ray Neidl - Maxim Group

You said that 18 aircraft are coming off of lease next year. How many of those are freighters?

Ron Wainshal

One, and that’s an A310 that we impaired and that we expect to part out.

Ray Neidl - Maxim Group

Okay, great. Do you guys have any target prices or targets that you have for return on equity, or ROIC?

Ron Wainshal

Our new investments were looking for ROEs that are in north of 15%. So, let me just comment on that briefly. We buy aircrafts or finance aircrafts in two different ways. One is with secured debt, and that’s going to be primarily newer aircraft where you can calc the ROA pretty easily because they are direct debt financing. For aircraft that we are purchasing with unsecured debt it’s more of a general calculation where we are assuming that our capital structure is roughly two-thirds debt and one-third equity. So just to illustrate it, if I were acquiring an aircraft with the return on assets with 12% and two-thirds of the cost structure is debt, and let’s say 6%, the resulting ROE for that one remaining third is about 24%. Maybe that helps you in terms of calculation.

Ray Neidl - Maxim Group

Okay, that was good. One last thing is, you sounded if you are mildly pessimistic about the economy next year and one, I was just wondering if that’s a correct interpretation and number two, if you are it might not be a good time to be increasing the dividend, you might want to be letting down the hedges a little bit if the economy doesn’t (inaudible) next year going through the recession?

Ron Wainshal

Well, look Ray, there is a couple of things. One is my expectations about the economy are not any great increases, I also don’t expect any major decreases either. Remember that particularly for the passenger market there is a stickiness, both on the way up and on the way down. We have seen pretty robust results in terms of traffic levels so far. I don’t think you are going to see that the passenger market move very quickly one way or the other. The freight market is the one market, it’s a business to business market where there is a pretty direct transmission of sentiment in terms of activity. I think there is more upside there than there is downside and there will be more pronounced, it’s more amplified. Maybe, I will turn it over to Mike to comment about the dividend in terms of our capability to do that.

Michael Inglese

Yes, I think, Ray, just fundamentally we have a cautious view about the economy but we are looking at the portfolio that we have and the earnings power in light of the cautious view and we think a 10% dividend increase makes a lot of sense and we feel very comfortable as the sustainable level given our view of the world and the performance of our business.

Ray Neidl - Maxim Group

Okay, great. Thank you.

Ron Wainshal

Just to add, the weakness in the economy is not a new thing yet the operating cash flow statistics for our business has been very robust. Two, Mike and team’s good work on the capital structure, we don’t have any debt refinancing for 5 years.

Ray Neidl - Maxim Group

Okay. That’s helpful. Thank you very much.

Ron Wainshal

Sure.

Operator

Our next question is from Helane Becker with Dahlman Rose.

Helane Becker - Dahlman Rose

Thanks very much, operator. Hi, guys.

Ron Wainshal

Hi, Helane, good morning.

Helane Becker - Dahlman Rose

Thanks you very much and I will remember to those. Thanks for the reminder actually. Here is one of my questions. I guess with the change in technology products are getting smaller, lighter and so I was wondering if the 747-400 freighter still makes a lot of sense, or if your customers aren’t starting to look at maybe the 777 freighter and what you think about shifting the mix away from the bigger aircraft to the more fuel efficient aircraft?

Ron Wainshal

Well, a couple of comments. The stuff that flies on freight is certainly influenced by high technology products and they are getting smaller and air freight charges are based on weight. However, that’s only a part of the picture. There is pharmaceuticals, there is perishables, there is machinery, there is a lot of things that fly by air and I don’t think you should over estimate what the effect of technology is. For some customers it’s a bigger deal than others, okay. So, that’s point number one. Point number two is, there are a few different types of 747s out there. There is something call the -8 which is coming out right now, which is 25%, 30% bigger than the 747-400. I have said this for a long time, I think that’s a real niche aircraft that particularly in a market like this it has a harder time justifying itself. For some carriers it may make sense but as a lessor I am not inclined towards it. I have also said consistently that over time I think the 777 will become the workhorse of the industry. It has roughly the same cargo capacity as a 747-400 freighter. Problem is you have got to wait years to get one. I think there is also a certain number of customers that are extremely capital cost sensitive. So, 777 is not a cheap item and it works along certain networks, but for a number of others that are perhaps low utilization or focusing on shorter geographic segments, 747 works just fine and we are still bullish on the type.

Helane Becker - Dahlman Rose

Got you. Okay. And then, I think you said and I think it’s in that handout as well that Asia is now a third of your portfolio and Europe actually come down to below 40% of the portfolio. As we think about the business over the next 18 months with the aircraft that are coming off lease, should we think about that kind of shifting mix away from Europe into Asia and do you have targets in mind or how are you thinking about that opportunistic or how should we think about that maybe a better question?

Ron Wainshal

A couple of different things. One is the portfolio reflects the evolution of the market and we don’t have a specific target for Europe, or Asia, or any one region. When we buy aircraft we make a decision about whether it’s a good deal or not, we are cognizant of exposures and concentrations but I think the biggest impact isn’t the fleet rollout because we only have 6% of our book rolling off next year. It’s going to be acquisitions.

Helane Becker - Dahlman Rose

(inaudible)

Ron Wainshal

No, I think the aircraft availability is there. I think a lot of the growth opportunities, particularly for the wide-bodies would come out of Asia.

Helane Becker - Dahlman Rose

Okay, got you. Are you being approached by any airlines to do like financing for some of their newer aircraft or some airlines that might have aircraft coming off lease looking to maybe refinance them by selling them and leasing them back from you guys, anything like that going on?

Ron Wainshal

Yes, that happened last quarter where we did a sale lease back with an Asian carrier for 737-800s. This is ongoing.

Helane Becker - Dahlman Rose

Got you. Okay, well thanks very much for now.

Ron Wainshal

Sure, thanks Helane.

Operator

Our next question is from Isaac Husseini with Barclays.

Isaac Husseini - Barclays Capital

Hi, good morning everyone. Ron, I was wondering if I can follow-up on something from the earnings release. You mentioned that one 747-400 that was supposed to be converted to a freighter aircraft is now being part of that. Which makes sense given the data that we have seen on the cargo side globally. I was wondering if you had more color to add on the specific aircraft because (inaudible) cargo weakness is something else. If it was because of cargo weakness, do you have any reason how that segment might perform in the next two to three or four quarters?

Ron Wainshal

Yes, hi, Isaac. We talked about this a little bit in our last earnings call but let me just refresh and amplify that. This was an aircraft that we bought back in 2011. It had a lease with Singapore Airlines that expired early this year. The freight market really hasn’t been strong. The last thing we wanted to do is to put another $25 million into an airplane, have it sit in the ground for half a year and not to have the good lease in place. So, it was a decision about the incremental deployment of capital, number one. So, as we sat there with this airplane we look at what was the best deployment of this asset and what we conclude was because of some strength in the engine market that it made sense for us, number one, to sell through the engines to customers. And also we have – these are 5400 engines, which also operate on the 767s in our fleet. We had two engines 767s that required extensive shop visits and it was far cheaper for us to take those run out engines, sell them and avoid the shot visit costs and in turn contribute this engine on the 747. In the end we sold the airframe as well and we made about $2 million profit on the whole proposition. That last bid is supposed to close in the fourth quarter. I think it’s more commentary on the best deployment of capital as opposed to the freight market per se. Incrementally, we got a good return on that investment than we avoided having something that’s was going to yield something sell parts.

Isaac Husseini - Barclays Capital

Okay, that’s helpful. Maybe one for Mike, the question got asked, but I want to try to get at it differently. Receivables look like they have ticked up in 3Q relative to the total revenue there about 4.5%. That looks like it’s relatively high, it haven’t been high since 2008 or maybe even early 2009. Is there anything going on over there in that line item that we should be aware of or think about?

Michael Inglese

No, I think as Ron said, if we look at where we were at the end of the quarter and where we are today we have like $1 million that’s over 30 days and 80% plus of that is related to the world bankruptcy. It’s a receivable that’s tied up and won’t get cleared. We have security deposits in excess of that amount sitting here, but there are locked up if you will until the world bankruptcy is resolved and until they exit. So, it’s not a particularly worrying thing for us at this point in time.

Isaac Husseini - Barclays Capital

Okay. If I can just speak one quick one. The two A320s that were terminated, are they going to be parted out? What’s the average age of those two aircraft and have you tried remarketing those?

Michael Inglese

Those are 91 and they are the older engine aircraft. To remarket those means you have reinvest those aircraft, to reinvest in those engines, it really just doesn’t make sense for us. I think the highest return on our capital is to keep the cash and sell them as they are.

Isaac Husseini - Barclays Capital

Okay, perfect. Thank you so much for the time.

Ron Wainshal

Thanks, Isaac.

Operator

Our next question comes from Jamie Baker with JP Morgan.

Jamie Baker - JP Morgan

Hi good morning, gentleman. My first question, I guess for Mike, on the write-down it works out to roughly $5 million per sell, you gave it for the effected aircraft types. But what does the write-down work out to on a percentage basis for each of the aircraft types? More a dollar basis if you would rather give it to way.

Michael Inglese

We didn’t break it out by aircraft type, Jamie. I mean, the total was about 1.7% of the net book value of the overall fleet of the business. So, it’s not a significant impact or item for us in the context of thinking about the future of the business.

Jamie Baker - JP Morgan

So, it’s not significant as it relates to the overall book, I am just trying to get an order of magnitude as to what it was for the individual types. So, if it works out to $5 million, was that $20 million to $15 million, or $10 million to $5 million?

Ron Wainshal

Jamie, it’s Ron. We are not going to get into the details, but I think it’s fair to say that the write-down is bigger for the 767s and for the 737-400s and for the 737-400s it was bigger for the later mile aircraft and the early ones.

Jamie Baker - JP Morgan

Okay, that’s helpful. Second, Ron, well, I have you. There has been an uptick in 737 classic freighter conversions, obviously off a really low base, but an uptick nonetheless classics are part of your business, freighters are part of your business. Should we be thinking it all about this in (inaudible) scare market or should we just ignore it?

Ron Wainshal

We have looked at this before and we will continue to look at it. But, as you may have detected from our team, a lot of what we are doing is about capital efficiency. So, if we think that investing an extra, called $3 million, of classic is a good return on capital as opposed to whatever other course exists for that airplane then we will do it. But at the moment I don’t see that being very big of what we are doing. We only have two 737s coming off, actually one 737 coming off lease in the next year, so the real opportunity for us isn’t that big.

Jamie Baker - JP Morgan

Okay, that’s what I think. Thank you very much.

Operator

Our next question comes from Justine Fisher with Goldman Sachs.

Justine Fisher - Goldman Sachs

Good morning.

Ron Wainshal

Hi, Justine.

Justine Fisher - Goldman Sachs

I was wondering if you guys are buyers of assets and you said that now it seems to be a better time to buy than to sell. I suspect that we might hear the same thing from other lessors. So, I was wondering what kind of parties do you think are going to be sellers of assets? Do you think other lessors are going to sell assets to you, do you think that you are going to end up with airlines that have classics to sell? I mean, what kind of entities will be the sellers, as I suspect many lessors will be better buyers.

Ron Wainshal

Not every lessor is situated in the same, number one. I think it will be a real mix like it has always has been for us. I gave the statistics about how many different transactions we have done, how many different counterparts we have done over the years, it’s a huge number. It will be mix. I mean, there are some lessors that have more financial pressures than others. For example, those that have debt balloons coming due, truly hard to refinance those these days. So, airlines that are looking at growth, airlines that are looking kind of an exit strategy for certain aircraft types, those are good customer targets as well. It will be a mix like it always has been.

Justine Fisher - Goldman Sachs

Would you be willing to buy aircraft types similar to those that you wrote-down, maybe not really old A320s but would you – it seems like they probably be more willing to sell older aircraft types rather than newer and would you be willing to buy some of those older aircraft types given that you took the impairment charge? I guess with the right price I think it makes sense but –

Ron Wainshal

Well, I am a very firm believer in the right price. You may note that earlier this year we did a sale lease back with Condor [ph] for number of 767s, those were treated financially, since they are basically to our sense of part out value. So, those are I think very rich deals and I would do that deal again. So, the answer is yes. There are some aircraft types that I think just because of the scale and because of the outlook that I have about them are probably not worth the time. I mentioned during the call that the number of part 737 classics keeps growing and that means that the residual value pressures keep growing as well. The ticket size is pretty small, probably not a good use of our time.

Justine Fisher - Goldman Sachs

Okay. And then, on the loan that you guys bought in March, I was just wondering, I know that you holded it available for sale. I don’t know have you got increase from others potentially (inaudible), how is the counterparty to that loan doing from a credit perspective given that we’ve seen a weakening environment?

Michael Inglese

Well, the counter party is American and I am actually quite comfortable with that loan as an investment. I would be a happy owner of that airplane, a very happy owner if that’s (inaudible) happening, but I don’t think that’s going to take place. The high yield markets pretty hot, although everyone is looking for yield, but I am very comfortable with this investment.

Justine Fisher - Goldman Sachs

Okay. And then, sorry one more question. I don’t know if you guys would be willing to give us any color as to what the usual lives, what usual lives you wrote assets down to?

Ron Wainshal

A couple of things. One is, we do an annual fleet review. Last year, we made a number of change. This isn’t the first time we’ve done something in the form of adjusting our fleet. For example, last year we reduced the useful life assumption for current generation A319 to 22.5 years. We reduced the residual values on our classics, 737 classics to $0.75 million, which was our sense of half flight breakup value. So, the write-downs that we have this year and the other adjustments that we have get into more of an asset specific determination. When you do a useful life estimate in the beginning of the acquisition you will probably take a view of something generic. But, our approach is when you get to the last life of the airplane you will have some specific views about maintenance cycle and whether it makes sense to reinvest or not. The short answer is it depends on each aircraft. Each aircraft is evaluated specifically for its maintenance that was projected and generally when there is a shop visit that’s when we pull the plug on it.

Michael Inglese

And Justine, just a little more color. In the contracts of the 737 classics basically the lives were shorten in the range like 2 to 4 years across each of those plans. On the 767s, it was closer to a year across the group of assets that got impaired based on where they are in the age and what we think is most likely economic profile for those assets as they head towards the 25-year original assumption.

Ron Wainshal

Right. It’s a triggering event in most cases and not a heavy short visit.

Justine Fisher - Goldman Sachs

Okay. Super, thanks so much.

Operator

Our next question is from Scott Valentin with FBR investment bank.

Scott Valentin - FBR Capital Markets

Good morning, everyone. Thanks for taking my questions. With regards to some of the other activity we have seen in the space, we have seen especially Japanese banks coming in and buying some of the lessors. Conceivably, the banks have a cost to capital advantage. Is there any fear that as banks become more involved in the space they start pushing down lease rates to add the lower cost of capital?

Ron Wainshal

I think the place where you see this and this is not limited to the two Japanese banks that bought Jackson’s Square and RDS. There are other banks like the Chinese banks that have been active for some time. There is a group of lessors I will say that are no reliant on funding on their own and they have been quite aggressive and they do have low debt cost because they don’t have to do on their own. Most of the capital is deployed in new narrow bodies. That’s not a sector we chose to play. We will see this in wide bodies from time to time and if we intent on growing at some really big great, then that would be more of a concern. But, I think our approach is to find the right situations and make sure that we are much disciplined about it. I don’t really think that is a particularly new issue. I understand the rational for those acquisitions, but I am not particularly troubled by them.

Scott Valentin - FBR Capital Markets

Okay, thanks. And then just a follow-up question. You mentioned the idea that you will see more sale-leaseback transactions in ’13. In terms of the RFPs received, is there more competition now than it was in the past in response to those RFPs? It seems like if internal “growth area” as many lessors are looking at some of the aircraft that airlines make [ph] available?

Ron Wainshal

Growth area for many lessors because there is more to do. I don’t think the competition is more than it has been in the past. I think on the wide-body side, there may be a few guys on margin as we do that the narrow-bodies were overbought. But I don’t think it’s a real sea change.

Scott Valentin - FBR Capital Markets

Okay. Thanks very much.

Ron Wainshal

Yes.

Operator

Our next question comes from Andrew Light with Citigroup.

Andrew Light - Citigroup

Hi, good morning.

Ron Wainshal

Good afternoon.

Andrew Light - Citigroup

Couple of questions. First of all, on that impairment charge of $78.7 million, what would that be as a percentage of the total net book value of those planes? Can you just give us a rough idea?

Michael Inglese

It’s a mix across the planes, Andrew, and I think this is what Andy was getting at, we just haven’t broken down that level of detail. And I think as Ron said, it’s a higher percentage of the 76s [ph] generally speaking in the newer 737s that were in that bucket and a smaller percentage in the context of the older Classic 73s and A310.

Andrew Light - Citigroup

Fine. I was just looking for the summary. I am not interested in individual aircraft types. (inaudible) for example, your price to book value.

Michael Inglese

We don’t have that detail broken out and we are not prepared to provide it.

Ron Wainshal

Yes, it would be a good indicator of anything, to be honest.

Andrew Light - Citigroup

Just interested in the percentage. Never mind. On your cargo exposure, I think it was about 25% of your portfolio, is that something you are happy with to maintain at that level, given that this is considering more than the reflection in the installed base or is this something you actually have purchased $800 million a year or so, you would like to diversify away from?

Ron Wainshal

Look, I don’t think that cargo market is long-term, something we will stay away from. We just look at deals one at a time to see if they make sense. There isn’t a priority percentage that’s allocated to one type for another. Would I buy more cargo aircraft? Yes, but it’s obviously going to have reflect the riskiness in the return profile of that particular investment. I don’t think you are going to see a big shift in the percentage of cargo. I am not particularly focused on taking placement risks unless I am really well compensated, but if the right sale-leaseback opportunity shows up, I might go for it.

Andrew Light - Citigroup

All right. I mean, where do you stand on the (inaudible) the Boeing 5% a year, twice GDP, and then there is the fuel prices and these interest rates and shippers generally trying to avid airfreight as best they can and use more surface and sea freight.

Ron Wainshal

Well, look, I think you have to take a view of this horizon that’s somewhere between these guys. Boeing is looking at 20 years out, which is not something that I use particularly in investment decisions. I am looking at something with a near-end environment, and I am also not making an investment decision based on six months horizon either. The shifts in the air cargo market happen in a faster rate than a passenger market, and it’s not the first time we have we have seen this, happened in 2009 and 2010 and yes, the market went roaring back in the back half of ’10 into ’11. So, you have to take a more stable view of the future when you are buying aircraft, because you are not trading these things on the Bloomberg. I think the outlook for the cargo market is pretty good. We are mindful of the changes in technology and the way people use air cargo and so on, but I think in general with increased Internet shipping and increased trade flows, the future is just fine.

Andrew Light - Citigroup

Okay, great. Thanks.

Operator

Our next question comes from Glenn Engel with Bank of America/Merrill Lynch.

Glenn Engel - Bank of America/Merrill Lynch

Good morning. A couple of questions, please. First is, why does it waiting make sense? You are saying there are good opportunities now, but there might be better opportunities a year from now than they are today. So, why do you – and probably that was true versus a year ago. So, why do you feel you have to do something today? Why don’t you just hold your cash and wait until things get even better?

Ron Wainshal

Look, when we find something that makes sense, we will pull the trigger. And maybe we will be right, maybe we will be wrong, but we have some hurdles and we have some – the deal flow doesn’t happen in a completely smooth and predictable way. And I think the folks that are able to move the sightscreen do well. And I don’t worry about the extra dollar or two that I might have left on the table, or, you know, I worry about the opportunity I might have lost. We have been very patient this year.

Glenn Engel - Bank of America/Merrill Lynch

Second question, during the summer, it seems not as much from you, but some others review that lease rates had somehow stabilized, is that still true or they started to soften again as we’ve hit this seasonably cash flow weaker period.

Ron Wainshal

When we look at lease rates, it is important to remember that negotiating a lease happens not in the very last minute if you are doing your job right and it doesn’t happen instantaneously, it takes several months to negotiate a lease. So, when things slow down on the margin if I ask for me today would you like another aircraft on lease, they are probably thinking 6 months ahead or maybe a little bit longer. There may be a (inaudible). I think in general the answer to your question is that it is kind of generally stable but some aircraft types are a little bit better relatively speaking than others. We’ve talked for a long time about the A320s and the weakness eventually you expect Boeing 737 and (inaudible) kind of fall in the line somewhat and we’ve actually seen a little bit more of a drop in the 737-800 lease rates. I would say there is an increase in the 320s. I think the strength has been more on the bigger airplane side.

Glenn Engel - Bank of America/Merrill Lynch

Finally, when would you expect the delays in deliveries for the 787 and I guess the A350 certainly help smaller wide body market, when do you start expecting that start putting pressure on some of the mid-age type wide body planes?

Ron Wainshal

It’ll take a few years, I think what is affecting the market right now is just the economy and confidence levels. I don’t think the 787 will really be felt in the market for a while.

Glenn Engel - Bank of America/Merrill Lynch

Thank you.

Operator

And our next question comes from Arren Cyganovich with Evercore.

Arren Cyganovich – Evercore

Thanks, just wanted a point of clarification on the two aircraft that you received the A320, the order A320 of the year, I guess you mentioned that about 10 million impairment that was separate from the 78 million impairment that you had from 15 aircrafts.

Mike Inglese

11.3 of the 78 was related to those two A320s that we did an early termination agreement with.

Arren Cyganovich – Evercore

Okay, because I thought you said something about there was an impairment related to those as well that made it -- loss of one million or something like that?

Mike Inglese

No, we had an impairment of 11.3 but offsetting it in the case of those two aircraft was maintenance revenue recognition as well as reversal of lease incentives that basically netted to net zero for the third quarter.

Arren Cyganovich – Evercore

Okay, in the 11.3 was that in the 78.7 impairment line.

Mike Inglese

That’s right.

Arren Cyganovich – Evercore

Okay, got you. And then I guess on to the guidance, the lease rental revenue guidance seemed a little bit lower than I was anticipating the 152 to 154, was there anything driving it a little bit lower on a quarter-to-quarter basis?

Mike Inglese

The recognition that we are going to have three 747 freighters largely off lease during the fourth quarter is the primary driver for the affect they see -- and then the transition from the Martinair one to a new customer.

Ron Wainshal

Having said that I expect that you’ll see those on lease maybe late this year, maybe early next year.

Arren Cyganovich – Evercore

And that is offsetting that as a little bit of an elevated maintenance revenue guidance of the 14 to 16 million?

Mike Inglese

You’ll see in some time, we have a number of aircraft transitioning during the fourth quarter including our expectations of the southern aircraft and then a few other narrow bodies, so some of that is embedded in the maintenance in the revenue guidance in the quarter, that is correct.

Arren Cyganovich – Evercore

Okay, thank you.

Operator

And that just conclude today’s question and answer session. I would like to turn the conference over to the speakers for any additional or closing remarks.

Mike Inglese

Thanks for your confidence, if you have any follow up questions feel free to call me at 203-504-1063. Have a good day.

Operator

And that does conclude today’s conference, we do thank you for your participation.

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