Notes to Consolidated Financial Statements

Note 8.
Finance Assets, net:

In 2003, PMCC shifted its strategic focus and is no longer making new investments but is instead focused on managing its existing portfolio of finance assets in order to maximize gains and generate cash flow from asset sales and related activities. Accordingly, PMCC’s operating companies income will fluctuate over time as investments mature or are sold. During 2005, 2004 and 2003, PMCC received proceeds from asset sales and maturities of $476 million, $644 million and $507 million, respectively, and recorded gains of $72 million, $112 million and $45 million, respectively, in operating companies income.

At December 31, 2005, finance assets, net, of $7,189 million were comprised of investments in finance leases of $7,737 million and other receivables of $48 million, reduced by allowance for losses of $596 million. At December 31, 2004, finance assets, net, of $7,827 million were comprised of investments in finance leases of $8,266 million and other receivables of $58 million, reduced by allowance for losses of $497 million.

A summary of the net investment in finance leases at December 31, before allowance for losses, was as follows:

At December 31, 2005, PMCC’s investment in finance leases was principally comprised of the following investment categories: aircraft (27%), electric power (26%), surface transport (21%), manufacturing (13%), real estate (11%) and energy (2%). Investments located outside the United States, which are primarily dollar-denominated, represent 20% and 19% of PMCC’s investments in finance leases in 2005 and 2004, respectively.

Among its leasing activities, PMCC leases a number of aircraft, predominantly to major United States passenger carriers. At December 31, 2005, $2.1 billion of PMCC’s finance asset balance related to aircraft. Two of PMCC’s aircraft lessees, Delta Air Lines, Inc. (“Delta”) and Northwest Airlines, Inc. (“Northwest”) are currently under bankruptcy protection, and a third lessee, United Air Lines, Inc. (“United”), exited bankruptcy on February 1, 2006. PMCC is not recording income on these leases. In addition, PMCC leases various natural gas-fired power plants to indirect subsidiaries of Calpine Corporation (“Calpine”), also currently under bankruptcy protection. PMCC is not recording income on these leases.

PMCC leases 24 Boeing 757 aircraft to United with an aggregate finance asset balance of $541 million at December 31, 2005. PMCC has entered into an agreement with United to amend 18 direct finance leases and United has assumed the 18 amended leases. There is no third-party debt associated with these leases. United remains current on lease payments due to PMCC on these 18 amended leases. PMCC continues to monitor the situation at United with respect to the six remaining aircraft financed under leveraged leases, in which PMCC has an aggregate finance asset balance of $92 million. United and the public debtholders have a court approved agreement that calls for the public debtholders to foreclose on PMCC’s interests in these six aircraft and transfer them to United. The foreclosure, expected to occur in 2006, subsequent to United’s emergence from bankruptcy, would result in the write-off of the $92 million finance asset balance against PMCC’s allowance for losses and the acceleration of tax payments in the amount of approximately $55 million on these leases.

In addition, PMCC has an aggregate finance asset balance of $257 million at December 31, 2005, relating to six Boeing 757, nine Boeing 767 and four McDonnell Douglas (MD-88) aircraft leased to Delta under leveraged leases. In November 2004, PMCC, along with other aircraft lessors, entered into restructuring agreements with Delta on all 19 aircraft. As a result of its agreement, PMCC recorded a charge to the allowance for losses of $40 million in the fourth quarter of 2004. As a result of Delta’s bankruptcy filing in September 2005, the restructuring agreement is no longer in effect and PMCC is at risk of having its interest in these aircraft foreclosed upon by the senior lenders under the leveraged leases. Should a foreclosure occur, it would also result in the write-off of the finance asset balance against PMCC’s allowance for losses and the acceleration of tax payments on these leases, and may require further provisions to increase the allowance for losses.

PMCC also leases three Airbus A-320 aircraft and five British Aerospace RJ85 aircraft to Northwest financed under leveraged leases with an aggregate finance asset balance of $62 million at December 31, 2005. Northwest filed for bankruptcy protection in September 2005. As a result of Northwest’s bankruptcy filing, PMCC is at risk of having its interest in these aircraft foreclosed upon by the senior lenders under the leveraged leases. Should a foreclosure occur, it would also result in the write-off of the finance asset balance against PMCC’s allowance for losses and the acceleration of tax payments on these leases.

In addition, PMCC’s leveraged leases for ten Airbus A-319 aircraft with Northwest have been rejected in the bankruptcy. As a result of the lease rejection, PMCC, as owner of the aircraft, recorded these assets on its consolidated balance sheet at the lower of net book value or fair market value. The adjustment to fair market value resulted in a $100 million charge against the allowance for losses in the fourth quarter of 2005. The assets are classified as held for sale and reflected in other assets on the consolidated balance sheet until such time as the assets are either sold or foreclosed upon by the lenders. In addition, the related nonrecourse debt is reflected in other liabilities on the consolidated balance sheet until such time as the underlying assets are either sold or foreclosed upon by the senior lenders. Should a foreclosure occur, it would result in the acceleration of tax payments on these aircraft of approximately $57 million.

In addition, PMCC leases 16 Airbus A-319 aircraft to US Airways, Inc. (“US Airways”) financed under leveraged leases with an aggregate finance asset balance of $150 million at December 31, 2005. In September 2005, US Airways emerged from bankruptcy protection and assumed the leases on PMCC’s aircraft without any changes. Also in September 2005, US Airways and America West Holdings Corp. (“America West”) completed a merger. PMCC leases five Airbus A-320 aircraft and three engines to America West with an aggregate finance asset balance of $44 million at December 31, 2005.

PMCC also leases two 265 megawatt (“MW”) natural gas-fired power plants (located in Tiverton, Rhode Island, and Rumford, Maine) and one 750 MW natural gas-fired power plant (located in Pasadena, Texas) to indirect subsidiaries of Calpine financed under leveraged leases with an aggregate finance asset balance of $206 million at December 31, 2005. On December 20, 2005, Calpine filed for bankruptcy protection. In the initial bankruptcy filing, PMCC’s lessees of the Tiverton and Rumford projects were included. On February 6, 2006, these leases were rejected. The Pasadena lessee did not file for bankruptcy but could file at a future date. Should a foreclosure on any of these projects occur, it would result in the write-off of the finance asset balance against PMCC’s allowance for losses and the acceleration of tax payments on these leases, and may require further provisions to increase the allowance for losses.

Due to continuing uncertainty within its airline portfolio and bankruptcy filings by Delta and Northwest, PMCC recorded a provision for losses of $200 million in September 2005. As a result of this provision, PMCC’s fixed charges coverage ratio did not meet its 1.25:1 requirement under a support agreement with ALG. Accordingly, as required by the support agreement, a support payment of $150 million was made by ALG to PMCC in September 2005.

Previously, PMCC recorded provisions for losses of $140 million in the fourth quarter of 2004 and $290 million in the fourth quarter of 2002 for its airline industry exposure. At December 31, 2005, PMCC’s allowance for losses, which includes the provisions recorded by PMCC for its airline industry exposure, was $596 million. It is possible that adverse developments in the airline or other industries may require PMCC to increase its allowance for losses.

Rentals receivable in excess of debt service requirements on third-party nonrecourse debt related to leveraged leases and rentals receivable from direct finance leases at December 31, 2005, were as follows:


                                                                 

Included in net revenues for the years ended December 31, 2005, 2004 and 2003, were leveraged lease revenues of $303 million, $351 million and $333 million, respectively, and direct finance lease revenues of $11 million, $38 million and $90 million, respectively. Income tax expense on leveraged lease revenues for the years ended December 31, 2005, 2004 and 2003, was $108 million, $136 million and $120 million, respectively.

Income from investment tax credits on leveraged leases and initial direct costs and executory costs on direct finance leases were not significant during the years ended December 31, 2005, 2004 and 2003.