Management's Discussion and Analysis of Financial Condition and Results of Operations

(Continued)

Discussion and Analysis > Operating Results by Business Segment > Financial Services > Business Environment

During 2003, PMCC shifted its strategic focus from an emphasis on the growth of its portfolio of finance leases through new investments to one of maximizing investment gains and generating cash flows from its existing portfolio of finance assets. Accordingly, PMCC’s operating companies income will decrease over time, although there may be fluctuations from year to year, as lease investments mature or are sold. During 2004 and 2003, PMCC received proceeds from asset sales and maturities of $644 million and $507 million, respectively, and recorded gains of $112 million and $45 million, respectively, in operating companies income.

Among its leasing activities, PMCC leases a number of aircraft, predominantly to major U.S. carriers. At December 31, 2004, approximately 27%, or $2.2 billion of PMCC’s aggregate finance asset balance related to aircraft. Two of PMCC’s lessees, United Air Lines, Inc. (“UAL”) and US Airways Group, Inc. (“US Airways”) are currently under bankruptcy protection and therefore PMCC has ceased recording income on these leases.

PMCC leases 24 Boeing 757 aircraft to UAL with an aggregate finance asset balance of $569 million at December 31, 2004. PMCC has entered into an agreement with UAL to amend 18 direct finance leases subject to UAL’s successful emergence from bankruptcy and assumption of the leases. UAL remains current on lease payments due to PMCC on these 18 amended leases. PMCC continues to monitor the situation at UAL with respect to the six remaining aircraft financed under leveraged leases, in which PMCC has an aggregate finance asset balance of $92 million. PMCC has no amended agreement relative to these leases since its interests are subordinate to those of public debt holders associated with the leveraged leases. Accordingly, since UAL has declared bankruptcy, PMCC has received no lease payments relative to these six aircraft and remains at risk of foreclosure on these aircraft by the senior lenders under the leveraged leases.

In addition, PMCC leases 16 Airbus A-319 aircraft to US Airways financed under leveraged leases with an aggregate finance asset balance of $150 million at December 31, 2004. US Airways filed for bankruptcy protection in September 2004. Previously, US Airways emerged from Chapter 11 bankruptcy protection in March 2003, at which time PMCC’s leveraged leases were assumed pursuant to an agreement with US Airways. Since entering bankruptcy again in September 2004, US Airways has entered into agreements with respect to all 16 PMCC aircraft which require US Airways to honor its lease obligations on a going forward basis until it either assumes or rejects the leases. If US Airways rejects the leases on these aircraft, PMCC is at risk of having its interest in these aircraft foreclosed upon by the senior lenders under the leveraged leases.

PMCC has an aggregate finance asset balance of $258 million at December 31, 2004, relating to six Boeing 757, nine Boeing 767 and four McDonnell Douglas (MD-88) aircraft leased to Delta Air Lines, Inc. (“Delta”) under long-term leveraged leases. PMCC and many other aircraft financiers entered into restructuring agreements with Delta in November 2004. As a result of its agreement, PMCC recorded a charge to the allowance for losses of $40 million. Delta remains current under its lease obligations to PMCC.

In recognition of ongoing concerns within its airline portfolio, PMCC recorded a provision for losses of $140 million in the fourth quarter of 2004. Previously, PMCC had recorded a provision for losses of $290 million in the fourth quarter of 2002 for its airline industry exposure. At December 31, 2004, PMCC’s allowance for losses, which includes the provisions recorded by PMCC for its airline industry exposure, was $497 million. It is possible that further adverse developments in the airline industry may require PMCC to increase its allowance for losses.

Operating Results

		Net Revenues									Operating Companies Income
	(in millions)			2004				2003		2002			2004			2003		2002
	Financial
	Services			$395				$432		$495			$144			$313		$55

PMCC’s net revenues for 2004 decreased $37 million (8.6%) from 2003, due primarily to the previously discussed change in strategy which resulted in lower lease portfolio revenues, partially offset by an increase of $66 million from gains on asset sales. PMCC’s operating companies income for 2004 decreased $169 million (54.0%) from 2003, due primarily to the 2004 provision for airline industry exposure discussed above, and the decrease in net revenues.

PMCC’s net revenues for 2003 decreased $63 million (12.7%) from 2002, due primarily to the previously discussed change in strategy which resulted in lower lease portfolio revenues. PMCC’s operating companies income for 2003 increased $258 million over 2002, due primarily to the previously discussed 2002 provision for airline industry exposure, partially offset by the impact of lower investment balances as a result of PMCC’s change in strategic direction.