Exhibit 99.1

PRELIMINARY NOTE

This Interim Report should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere in this Interim Report and with our Annual Report on Form 20-F, for the year ended December 31, 2017.

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and are presented in U.S. Dollars. These statements and discussion below contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, objectives, expectations and intentions and other statements contained in this Interim Report that are not historical facts, as well as statements identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” or words of similar meaning. Such statements address future events and conditions concerning matters such as, but not limited to, our earnings, cash flow, liquidity and capital resources, compliance with debt and other restrictive financial and operating covenants, interest rates, dividends, and acquisitions and dispositions of aircraft. These statements are based on current beliefs or expectations and are inherently subject to significant uncertainties and changes in circumstances, many of which are beyond our control. Actual results may differ materially from these expectations due to changes in political, economic, business, competitive, market and regulatory factors. We believe that these factors include but are not limited to those described under Item 3 “Key Information — Risk Factors” and elsewhere in our Annual Report on Form 20-F, for the year ended December 31, 2017.

Except to the extent required by applicable law or regulation, we undertake no obligation to update these forward looking statements to reflect events, developments or circumstances after the date of this document, a change in our views or expectations, or to reflect the occurrence of future events.

Unless the context requires otherwise, when used in this Interim Report, (1) the terms “Fly,” “Company,” “we,” “our” and “us” refer to Fly Leasing Limited and its subsidiaries; (2) the term “B&B Air Funding” refers to our subsidiary, Babcock & Brown Air Funding I Limited; (3) the term “Fly Acquisition III” refers to our subsidiary, Fly Acquisition III Limited; (4) all references to our shares refer to our common shares held in the form of American Depositary Shares, or ADSs; (5) the term “BBAM LP” refers to BBAM Limited Partnership and its subsidiaries and affiliates; (6) the terms “BBAM” and “Servicer” refer to BBAM Aircraft Management LP, BBAM Aircraft Management (Europe) Limited, BBAM Aviation Services Limited and BBAM US LP, collectively; (7) the term “Manager” refers to Fly Leasing Management Co. Limited, the Company’s manager; (8) the term “GAAM” refers to Global Aviation Asset Management; and (9) the term “AirAsia Transactions” refers to the pending acquisition by Fly of (i) a portfolio of 34 Airbus A320-200 aircraft and seven engines, on operating leases, from AirAsia Berhad (“AirAsia”) and its subsidiary, Asia Aviation Capital Limited (“AACL”) in 2018, (ii) the portfolio of 21 Airbus A320neo family aircraft on operating leases to AirAsia and its affiliated airlines (the “AirAsia Group”) to be acquired as the aircraft deliver between 2019 and 2021 and (iii) the options to purchase an additional 20 Airbus A320neo family aircraft, not subject to lease, which begin delivering as early as 2019.

 

INDEX

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

(1)	The associated deferred tax expense was $1.0 million and $1.3 million for the three and six months ended June 30, 2018, respectively. The associated deferred tax benefit was $0.1 million and deferred tax expense was $0.2 million for the three and six months ended June 30, 2017, respectively.

(2)	The associated deferred tax expense was $0.1 million for each of the three and six months ended June 30, 2018. The associated deferred tax expense was $32,000 and $0.1 million for the three and six months ended June 30, 2017, respectively.

The accompanying notes are an integral part of these consolidated financial statements.

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Fly Leasing Limited

 

Notes to Consolidated Financial Statements

For the three and six months ended June 30, 2018

 

1. ORGANIZATION

 

Fly Leasing Limited (“Fly”) is a Bermuda exempted company that was incorporated on May 3, 2007, under the provisions of Section 14 of the Companies Act 1981 of Bermuda. Fly was formed to acquire, finance, lease and sell commercial jet aircraft directly or indirectly through its subsidiaries (Fly and its subsidiaries collectively, the "Company").

 

Although Fly is organized under the laws of Bermuda, it is a resident of Ireland for tax purposes and is subject to Irish corporation tax on its income in the same way, and to the same extent, as if it was organized under the laws of Ireland.

 

In accordance with Fly’s amended and restated bye-laws, Fly issued 100 shares (“Manager Shares”) with a par value of $0.001 to Fly Leasing Management Co. Limited (the “Manager”) for no consideration. Subject to the provisions of Fly’s amended and restated bye-laws, the Manager Shares have the right to appoint the nearest whole number of directors to Fly which is not more than 3/7th of the number of directors comprising the board of directors. The Manager Shares are not entitled to receive any dividends, are not convertible into common shares and, except as provided for in Fly’s amended and restated bye-laws, have no voting rights.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

BASIS OF PREPARATION

 

Fly is a holding company that conducts its business through its subsidiaries. Fly directly or indirectly owns all of the common shares of its consolidated subsidiaries. The consolidated financial statements presented are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The consolidated financial statements include the accounts of Fly and all of its subsidiaries. In instances where it is the primary beneficiary, the Company consolidates a Variable Interest Entity (“VIE”). Fly is deemed the primary beneficiary when it has both the power to direct the activities of the VIE that most significantly impact the economic performance of such VIE, and it bears the significant risk of loss and participates in gains of the VIE. All intercompany transactions and balances have been eliminated. The consolidated financial statements are stated in U.S. Dollars, which is the principal operating currency of the Company.

 

The Company's interim financial statements reflect all normally recurring adjustments that are necessary to fairly state the results for the interim periods presented. Certain information and footnote disclosures required by U.S. GAAP for complete annual financial statements have been omitted and, therefore, the Company's interim financial statements should be read in conjunction with its Annual Report on Form 20-F for the year ended December 31, 2017, filed with the SEC on March 14, 2018 (the "2017 Annual Report"). The results of operations for the three and six months ended June 30, 2018 are not necessarily indicative of those for a full fiscal year.

 

The Company has one operating and reportable segment which is aircraft leasing.

 

USE OF ESTIMATES

 

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The use of estimates is or could be a significant factor affecting the reported carrying values of flight equipment, deferred tax assets, liabilities and reserves. To the extent available, the Company utilizes industry specific resources, third-party appraisers and other materials to support management’s estimates, particularly with respect to flight equipment. Despite management’s best efforts to accurately estimate such amounts, actual results could differ from those estimates.

 

NEW ACCOUNTING PRONOUNCEMENTS

 

In February 2016, the Financial Accounting Standards Board (the "FASB") issued its new lease guidance, ASU 2016-02, Leases (Topic 842) . Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) on the commencement date: (i) lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. FASB has decided that lessors will be precluded from recognizing selling profit and revenue at lease commencement for any finance lease that does not transfer control of the underlying asset to the lessee. In addition, the new guidance will require lessors to capitalize, as initial direct costs, only those costs that are incurred in connection with the execution of a lease. Any other costs incurred, including allocated indirect costs, will no longer be capitalized and instead will be expensed as incurred. As of June 30, 2018, the Company had approximately $2.0 million of unamortized lease costs. The guidance will be effective for annual reporting periods (including interim periods) beginning after December 15, 2018, and early adoption is permitted. The new guidance must be adopted using the modified retrospective method. The Company is progressing in its assessment of the impact of ASC 842 and is concurrently gathering business requirements for the implementation of ASC 842. The Company plans to adopt the guidance effective January 1, 2019.

 

In August 2017, FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815). ASU 2017-12 is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. Under the guidance, if a cash flow hedge is highly effective, all changes in the fair value of the derivative hedging instrument will be recorded in other comprehensive income and reclassified to earnings when the hedged item impacts earnings. After initial qualification, the new guidance permits a qualitative effectiveness assessment for certain hedges instead of a quantitative test, such as a regression analysis, if the company can reasonably support an expectation of high effectiveness throughout the term of the hedge. An initial quantitative test to establish that the hedge relationship is highly effective is still required. Additional disclosures include cumulative basis adjustments for fair value hedges and the effect of hedging on individual income statement line items. The guidance will be effective for annual reporting periods (including interim periods) beginning after December 15, 2018, and early adoption will be permitted. The Company plans to adopt the guidance effective January 1, 2019.

 

In July 2018, FASB issued new guidance to provide entities with relief from the costs of implementing certain aspects of the new leases standard, ASU 2016-02, Leases (Topic 842) . Under a new transition method, entities can elect to not restate comparative periods presented in financial statements in the period of adoption. Instead, a reporting entity would:

 

·

Initially apply the new lease requirements at the effective date, and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption

 

·

Continue to report comparative periods presented in the financial statements in the period of adoption under current GAAP

 

·

Provide the required disclosures under ASC 840, Leases , for all periods presented under ASC 840

 

The FASB also issued a new practical expedient that allows lessors to elect not to separate lease and associated lease components within a contract if the following conditions are met:

 

·

The timing and pattern of transfer for the non-lease component and the associated lease component are the same; and

 

·

The stand-alone lease component would be classified as an operating lease if accounted for separately.

 

The new transition method does not impact the manner of adoption. An entity must still apply the modified transition approach when implementing the new guidance. The Company plans to adopt the guidance effective January 1, 2019.

 

4. INVESTMENT IN FINANCE LEASE

 

At June 30, 2018 and December 31, 2017, the Company had one investment in finance lease, which had an implicit interest rate of 5%. During the three and six months ended June 30, 2018, the Company recognized finance lease revenue totaling $0.2 million and $0.3 million, respectively. During the three and six months ended June 30, 2017, the Company recognized finance lease revenue totaling $0.2 million and $0.4 million, respectively.

 

The Company’s net investment in finance lease consisted of the following (dollars in thousands):

 

5. FLIGHT EQUIPMENT HELD FOR OPERATING LEASE, NET

 

As of June 30, 2018, the Company had   84 aircra ft held for operating lease on lease to 44 lessees in 26 countries. As of December 31, 2017, the Company had 84 aircraft held for operating lease, of which 82 aircraft were on lease to 43 lessees in 27 countries, and two aircraft were off-lease.

During the six months ended June 30, 2018, the Company purchased two aircraft held for operating lease, and capitalized $65.7 million. During the six months ended June 30, 2017, the Company purchased five aircraft held for operating lease, and capitalized $289.6 million.

 

The Company sold two aircraft held for operating lease during the three and six months ended June 30, 2018 and recognized a gain on sale of aircraft of $2.9 million in each period. The Company did not sell any aircraft held for operating lease during the three or six months ended June 30, 2017.

 

As of June 30, 2018 and December 31, 2017, flight equipment held for operating lease, net, consisted of the following (dollars in thousands):

 

The Company capitalized $8.4 million and $5.3 million of major maintenance expenditures for the six months ended June 30, 2018 and 2017, respectively.

 

The classification of the net book value of flight equipment held for operating lease, net and operating lease revenue by geographic region in the tables and discussion below is based on the principal operating location of the lessees.

 

The distribution of the net book value of flight equipment held for operating lease by geographic region is as follows (dollars in thousands):

 

 

The distribution of operating lease revenue by geographic region for the three months ended June 30, 2018 and 2017 is as follows (dollars in thousands):

 

The distribution of operating lease revenue by geographic region for the six months ended June 30, 2018 and 2017 is as follows (dollars in thousands):

 

In each of the three and six months ended June 30, 2018 and 2017, the Company had one customer (Air India) that accounted for 10% or more of total operating lease revenue.

The Company places a lessee on non-accrual status when it has determined that it is not probable that the economic benefits of the lease will be received by the Company. At each of June 30, 2018 and 2017, there was no lessee on non-accrual status.

End of lease income and amortization of lease incentives recognized during the three and six months ended June 30, 2018 and 2017 are as follows (dollars in thousands):

As of each of June 30, 2018 and December 31, 2017, the weighted average remaining lease term of the Company’s aircraft held for operating lease was 6.3 years.

 

On October 3, 2014, Fly sold $325.0 million aggregate principal amount of 6.375% Senior Notes due 2021 (the “2021 Notes”). On October 16, 2017, Fly sold $300.0 million aggregate principal amount of unsecured 5.250% Senior Notes due 2024 (the “2024 Notes”).

The 2021 Notes and 2024 Notes are unsecured obligations of Fly and rank pari passu in right of payment with any existing and future senior indebtedness of Fly. The 2021 Notes have a maturity date of October 15, 2021 and the 2024 Notes have a maturity date of October 15, 2024.

Interest on the 2021 Notes and 2024 Notes is payable semi-annually on April 15 and October 15 of each year. As of June 30, 2018 and December 31, 2017, accrued interest on unsecured borrowings totaled $7.7 million.

Pursuant to the indentures governing the 2021 Notes and 2024 Notes, the Company is subject to restrictive covenants which relate to dividend payments, incurrence of debt and issuance of guarantees, incurrence of liens, repurchases of common shares, investments, disposition of aircraft, consolidation, merger or sale of the Company and transactions with affiliates. The Company is also subject to certain operating covenants, including reporting requirements. The Company’s failure to comply with any of the covenants under the indentures governing the 2021 Notes or 2024 Notes could result in an event of default which, if not cured or waived, may result in the acceleration of the indebtedness thereunder and other indebtedness containing cross-default or cross-acceleration provisions. Certain of these covenants will be suspended if the 2021 Notes or 2024 Notes obtain an investment grade rating. As of June 30, 2018, the Company was not in default under the indentures governing the 2021 Notes or the 2024 Notes.

For more information about Fly's unsecured borrowings, refer to Note 10 of the 2017 Annual Report.

 

(1)	Represents the contractual interest rates and effect of derivative instruments and excludes the amortization of debt discounts and debt issuance costs.

 

(2)	As of June 30, 2018 and December 31, 2017, accrued interest on secured borrowings totaled $6.7 million and $6.6 million, respectively.

 

The Company is subject to restrictive covenants under its secured borrowings which relate to the incurrence of debt, issuance of guarantees, incurrence of liens or other encumbrances, the acquisition, substitution, disposition and re-lease of aircraft, maintenance, registration and insurance of its aircraft, restrictions on modification of aircraft and capital expenditures, and requirements to maintain concentration limits.

 

The Company’s loan agreements include events of default that are customary for these types of secured borrowings. The Company’s failure to comply with any restrictive covenants, or any other operating covenants, may trigger an event of default under the relevant loan agreement. In addition, certain of the Company’s loan agreements contain cross-default provisions that could be triggered by a default under another loan agreement.

 

As of June 30, 2018, the Company was not in default under any of its secured borrowings.

 

For more information about the Company's secured borrowings, refer to Note 11 of the 2017 Annual Report.

 

Securitization Notes

 

As of June 30, 2018, Fly’s subsidiary, B&B Air Funding, had $96.0 million principal amount outstanding on its aircraft lease-backed Class G-1 notes (the “Securitization Notes”), which were secured by nine aircraft. The final maturity date of the Securitization Notes is November 14, 2033. The Securitization Notes are non-recourse obligations to Fly.

 

The Securitization Notes bear interest at an adjustable interest rate equal to the current one-month LIBOR plus 0.77%. Interest expense also includes amounts payable to the provider of a financial guaranty insurance policy and the liquidity facility provider thereunder, as well as accretion on the Securitization Notes re-issued at a discount. Interest and any principal payments due are payable monthly.

 

All cash collected, including sale proceeds from the aircraft financed by the Securitization Notes, is applied to service the outstanding balance of the Securitization Notes, after the payment of certain expenses and other costs, including interest, interest rate swap payments, and the fees to the policy provider in accordance with those agreements.

 

B&B Air Funding is subject to operating covenants which relate to, among other things, its operations, disposition of aircraft, lease concentration limits, and restrictions on the modification of aircraft and capital expenditures. A breach of the covenants could result in the acceleration of the Securitization Notes and exercise of remedies available in relation to the collateral, including the sale of aircraft at public or private sale.

 

Nord LB Facility

 

As of June 30, 2018, the Company had $121.5 million principal amount outstanding under its non-recourse debt facility with Norddeutsche Landesbank Gironzentrale (the “Nord LB Facility”), which was secured by five aircraft. The Nord LB Facility is structured with loans secured by each aircraft individually. The loans are cross-collateralized and contain cross-default provisions. Borrowings are secured by Fly’s equity interests in the aircraft owning and leasing subsidiaries, the related leases, and certain deposits. The loans under the Nord LB Facility bear interest at one-month LIBOR plus 3.30%. The Nord LB Facility matures on November 14, 2018, and the Company is in discussions with the lender to extend the maturity date.

 

Under the terms of the Nord LB Facility, the Company applies 95% of lease rentals collected towards interest and principal. If no lease rental payments are collected in the applicable period for any financed aircraft, then no payment is due under the loan associated with that aircraft during such period. Any unpaid interest increases the principal amount of the associated loan.

 

In the event the Company sells any of the financed aircraft, substantially all sale proceeds (after payment of certain expenses) must first be used to repay the debt associated with such aircraft and then to repay the outstanding amounts which finance the remaining aircraft. In addition, any maintenance reserve amounts retained by the Company will be used to prepay the Nord LB Facility, provided such reserves are not required for future maintenance of such aircraft.

 

CBA Facility

 

As of June 30, 2018, the Company had $45.2 million principal amount outstanding under its debt facility with Commonwealth Bank of Australia and CommBank Europe Limited (the “CBA Facility”), which was secured by four aircraft. Fly has guaranteed all payments under the CBA Facility. These loans are cross-collateralized and contain cross-default provisions. The final maturity date of each of the four loans is October 28, 2020.

 

The Company makes scheduled monthly payments of principal and interest on each loan in accordance with a fixed amortization schedule. If, upon the repayment of any loan, the ratio of the remaining principal amount outstanding under the CBA Facility to the aggregate appraised value of the financed aircraft is equal to or greater than 80%, the Company will be required to pay cash collateral in an amount sufficient to reduce this ratio to less than 80%.

 

Borrowings under the CBA Facility accrue interest at a fixed interest rate.

 

The CBA Facility includes certain operating covenants, including reporting requirements. A breach of the covenants could result in the acceleration of outstanding indebtedness under the CBA Facility, and exercise of remedies available in relation to the collateral.

 

Term Loan

 

As of June 30, 2018, the Company had $419.0 million principal amount outstanding under its senior secured term loan (the “Term Loan”), which was secured by 30 aircraft. Fly has guaranteed all payments under the Term Loan. The final maturity date of the Term Loan is February 9, 2023.

The Term Loan bears interest at three-month LIBOR, plus a margin of 2.00%. The Term Loan can be prepaid in whole or in part at par.

 

The Term Loan requires that the Company maintain a maximum loan-to-value ratio of 70.0% based on the lower of the mean or median of half-life adjusted base values of the financed aircraft as determined by three independent appraisers. The Term Loan also includes other customary covenants, including reporting requirements and maintenance of credit ratings.

 

Magellan Acquisition Limited Facility

 

On December 8, 2017, Fly, through a wholly-owned subsidiary, entered into a term loan facility with a consortium of lenders (the “Magellan Acquisition Limited Facility”) providing for loans and notes with a final maturity date of December 8, 2025. As of June 30, 2018, the Company had $318.5 million principal amount outstanding under t he Magellan Acquisition Limited Facility which was secured by nine aircraft. Fly has guaranteed all payments under this facility.

The interest rate on the loans is based on one-month LIBOR plus an applicable margin of 1.65% per annum. The interest rate on the notes is a fixed rate of 3.93% per annum.

 

The facility contains financial and operating covenants, including a covenant that Fly maintain a tangible net worth of at least $325.0 million, as well as customary reporting requirements. The borrower is required to maintain an initial loan-to-value ratio of less than or equal to 75% based on the lower of the average half-life adjusted current market value and base value of all aircraft financed under the facility as determined by three independent appraisers. A violation of any of these covenants could result in a default under the Magellan Acquisition Limited Facility. In addition, upon the occurrence of certain conditions including a failure by Fly to maintain a minimum liquidity of at least $25.0 million, the borrower will be required to deposit certain amounts of maintenance reserves and security deposits received into accounts pledged to the security trustee.

 

Fly Acquisition III Facility

 

In February 2016, Fly, through a wholly-owned subsidiary, entered into a revolving $385.0 million credit facility (the “Fly Acquisition III Facility”) to finance the acquisition of eligible aircraft. The Fly Acquisition III Facility has an availability period expiring on February 26, 2019 and a maturity date of February 26, 2022. Fly has guaranteed all payments under the facility.

 

As of June 30, 2018, the Company had $131.3 million principal amount outstanding, which was secured by six aircraft.

 

The Company pays a commitment fee of 0.50% per annum on a monthly basis to each lender on the undrawn amount of its commitment until the termination of the availability period; provided that at any time from and after March 26, 2017 through the end of the availability period, the commitment fee will increase to 0.75% per annum if at least 50% of the total amount of commitments have not been drawn.

 

The interest rate under the facility is based on one-month LIBOR plus an applicable margin. The applicable margin is 2.00% through the expiration of the availability period and will increase to 2.50% from February 27, 2019 through February 26, 2020, and 3.00% from February 27, 2020 through the maturity date of the facility.

 

The Fly Acquisition III Facility contains financial and operating covenants, including covenants that Fly maintain a tangible net worth of at least $325.0 million and that Fly Acquisition III maintain a specified interest coverage ratio, as well as customary reporting requirements. Violation of any of these covenants could result in an event of default under the facility. Also, upon the occurrence of certain conditions, including a failure by Fly to maintain a minimum liquidity of at least $25.0 million, Fly Acquisition III will be required to deposit maintenance reserves and security deposits received from lessees into accounts pledged to the security trustee.

 

 Fly Aladdin Acquisition Facility

 

On June 15, 2018, Fly, through its wholly-owned subsidiaries, entered into a term loan facility with a consortium of lenders (the “Fly Aladdin Acquisition Facility”) to finance the acquisition of 29 Airbus A320-200 aircraft on operating leases to the AirAsia Group, and one Airbus A320-200 aircraft on operating lease to a third-party airline (see Note 14). The Company paid aggregate arrangement and commitment fees of approximately $5.1 million to the lenders upon entering into the facility. Additional arrangement fees of approximately $4.5 million will be payable upon drawing funds thereunder.

The Fly Aladdin Acquisition Facility provides for borrowings of an aggregate of $574.5 million, including $143.6 million Series A loans with a final maturity date of June 15, 2020, and $430.9 million Series B loans with a final maturity date of June 15, 2023. The Company may elect, at any time prior to May 16, 2020, to extend the maturity date in respect of Series A loans having an original principal amount no greater than 40% of the original drawn amount to January 15, 2021. A s of June 30, 2018, t he Company had not drawn under the facility (see Note 17).

The interest rate on the loans is based on three-month LIBOR, plus an applicable margin of 1.50% per annum for the Series A loans, 1.80% per annum for the Series B loans, and 2.50% per annum during the extension term for any Series A loans that the Company elects to extend. The Company will make scheduled quarterly payments of principal and interest on each loan in accordance with a fixed amortization schedule.

 

Borrowings will be secured by the aircraft and related leases, and the shares in the aircraft owning and leasing entities. In addition, Fly has provided a guaranty of certain of the representations, warranties and covenants under the Fly Aladdin Acquisition Facility (including, without limitation, the borrowers’ special purpose covenants), as well as the Company's obligations, upon the occurrence of certain conditions, to deposit maintenance reserves and security deposits received into pledged accounts.

 

The borrowers are required to maintain (i) a debt service coverage ratio of at least 1.15:1.00, (ii) an initial loan-to-value ratio equal to 72.5% and (iii) that 85% of aircraft financed under the facility are utilized by (i) being on lease, (ii) having been subject to a lease in the previous six months or (iii) being subject to a letter of intent for a re-lease or sale. The tests in (ii) and (iii) will be based on the average of the most recent half-life adjusted current market value of all aircraft financed under the facility, as determined by three independent appraisers on a semi-annual basis. Upon the occurrence of (i) a breach of the debt service coverage ratio continuing for two consecutive quarterly payment dates, (ii) an event of default that is continuing under the Fly Aladdin Acquisition Facility, or (iii) a default under any mortgage, indenture or instrument under which there is issued, or which secures or evidences, any recourse indebtedness of the Company in an aggregate principal amount exceeding $50.0 million, Fly will be required to deposit, or cause the borrowers to deposit, all maintenance reserves and security deposits received under the associated leases into pledged accounts. Upon the occurrence of a breach, on any payment date, of the loan-to-value ratio or the utilization test described above, and certain other events, all cash collected will be applied to repay the outstanding principal balance of the Series A and Series B loans until such breach is cured.

 

The Fly Aladdin Acquisition Facility contains geographic and single lessee concentration limits, which apply upon the acquisition, sale, removal or substitution of an aircraft, as well as aircraft type eligibility for any aircraft substitution. Upon the sale of an aircraft, the borrowers may substitute an Airbus A320 or A321 model aircraft on operating lease to the AirAsia Group into the Fly Aladdin Acquisition Facility subject to certain conditions. The facility also includes certain customary covenants, including reporting requirements. A violation of any of these covenants could result in a default under the Fly Aladdin Acquisition Facility.

 

Other Aircraft Secured Borrowings

 

The Company has entered into other aircraft secured borrowings to finance the acquisition of aircraft, one of which is denominated in Euros. As of June 30, 2018, the Company had $801.0 million principal amount outstanding of other aircraft secured borrowings, which was secured by 18 aircraft. Of this amount, $452.8 million was recourse to Fly.

 

These borrowings are structured as individual loans secured by pledges of the Company’s rights, title and interests in the financed aircraft and leases. In addition, Fly may provide guarantees of its subsidiaries’ obligations under certain of these loans and may be subject to financial and operating covenants in connection therewith. The maturity dates of these loans range from September 2019 to June 2028.

 

9. DERIVATIVES

 

Derivatives are used by the Company to manage its exposure to identified risks, such as interest rate and foreign currency exchange fluctuations. The Company uses interest rate swap contracts to hedge variable interest payments on loans associated with aircraft with fixed rate rentals. As of June 30, 2018, the Company had $1.1 billion of floating rate debt associated with aircraft with fixed rate rentals.

 

Interest rate swap contracts allow the Company to pay fixed interest rates and receive variable interest rates with the swap counterparty based on either the one-month or three-month LIBOR applied to the notional amounts over the life of the contracts. As of June 30, 2018 and December 31, 2017, the Company had interest rate swap contracts with notional amounts aggregating $0.9 billion and $0.7 billion, respectively. The unrealized fair value gain on the interest rate swap contracts, reflected as derivative assets, was $8.9 million and $2.6 million as of June 30, 2018 and December 31, 2017, respectively. The unrealized fair value loss on the interest rate swap contracts, reflected as derivative liabilities, was $2.7 million and $7.3 million as of June 30, 2018 and December 31, 2017, respectively.

 

During the six months ended June 30, 2018, Fly entered into interest rate derivative contracts to partially lock-in the interest rate on anticipated future borrowings associated with the AirAsia Transactions (see Note 8). The unrealized fair value gain of these interest rate derivative contracts, reflected as derivative assets, was $0.2 million as of June 30, 2018. The unrealized fair value loss of these interest rate derivative contracts, reflected as derivative liabilities, was $0.6 million as of June 30, 2018.

 

To mitigate its exposure to foreign currency exchange fluctuations, the Company entered into a cross currency swap contract in 2018 in conjunction with a lease in which a portion of the lease rental is denominated in Euros. Pursuant to such cross currency swap, the Company receives U.S. dollars based on a fixed conversion rate through the maturity date of the swap contract. As of June 30, 2018, the Company had a Euro cross currency swap contract with a notional amount of $91.2 million. The unrealized fair value gain, reflected as a derivative asset, was $0.9 million.

 

The Company determines the fair value of derivative instruments using a discounted cash flow model. The model incorporates an assessment of the risk of non-performance by the swap counterparty in valuing derivative assets and an evaluation of the Company’s credit risk in valuing derivative liabilities.

 

The Company considers in its assessment of non-performance risk, if applicable, netting arrangements under master netting agreements, any collateral requirement, and the derivative payment priority in the Company’s debt agreements. The valuation model uses various inputs including contractual terms, interest rate curves and credit spreads.

 

Designated Derivatives

 

The Company's cross currency swap and certain of its interest rate derivatives have been designated as cash flow hedges. The effective portion of changes in fair value of these derivatives are recorded as a component of accumulated other comprehensive income, net of a provision for income taxes. Changes in the fair value of these derivatives are subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.

 

As of June 30, 2018, the Company had the following designated derivative instruments classified as derivative assets on its balance sheet (dollars in thousands):

Dedesignated and Undesignated Derivatives

 

Certain of the Company’s interest rate swap contracts no longer qualify for hedge accounting and have been dedesignated. At June 30, 2018, the Company had an accumulated other comprehensive loss, net of tax, of $2.7 million, which is being amortized over the term of the interest rate swap contracts. During the three and six months ended June 30, 2018, $1.1 million and $1.9 million, respectively, was recognized as interest expense.

 

Fly did not designate as an accounting hedge the interest rate derivative contracts entered into during the six months ended June 30, 2018 to partially lock-in the interest rate on anticipated future borrowings associated with the AirAsia Transactions. Changes in the fair value of undesignated derivative instruments are recognized as gain or loss on derivatives in each reporting period.

 

As of June 30, 2018, the Company had the following dedesignated and undesignated derivative instruments classified as derivative assets on its balance sheet (dollars in thousands):

 

As of June 30, 2018, the Company had the following dedesignated and undesignated derivative instruments classified as derivative liabilities on its balance sheet (dollars in thousands):

 

10. INCOME TAXES

 

Fly is a tax resident of Ireland and has wholly-owned subsidiaries in Ireland, France, Luxembourg, Australia, Singapore, Labuan and Malta that are tax residents in those jurisdictions. In general, Irish resident companies pay corporation tax at the rate of 12.5% on trading income and 25.0% on non-trading income. Historically, most of the Company’s operating income has been trading income in Ireland.

 

The Company's effective tax rates were 13.8% and 15.4% for the three and six months ended June 30, 2018, respectively, and 24.7% and 20.3% for the three and six months ended June 30, 2017, respectively. The difference between the statutory and effective tax rate in each period is primarily attributable to changes in valuation allowances and the amount of income earned by the Company in different tax jurisdictions. The Company recognizes a valuation allowance   if,   based on the weight of available evidence, it is more-likely-than-not (likelihood of more than 50 percent) that some portion, or all, of its deferred tax asset will not be realized . Future realization of a deferred tax asset depends on the existence of sufficient taxable income of the appropriate character in the carryforward period under the tax law.

 

The Company had no unrecognized tax benefits as of June 30, 2018 or December 31, 2017.

11. SHAREHOLDERS’ EQUITY

 

In November 2017, Fly’s board of directors approved a $50.0 million share repurchase program expiring in December 2018. Under this program, Fly may make share repurchases from time to time in the open market or in privately negotiated transactions. During the six months ended June 30, 2018, Fly did not repurchase any shares.

 

During the six months ended June 30, 2017, Fly repurchased 2,081,471 shares at an average price of $13.06 per share, or $27.2 million, before commissions and fees.

 

12. SHARE-BASED COMPENSATION

On April 29, 2010, Fly adopted the 2010 Omnibus Incentive Plan (“2010 Plan”) permitting the issuance of up to 1,500,000 share grants in the form of (i) SARs; (ii) RSUs; (iii) nonqualified stock options; and (iv) other stock-based awards. Fly has issued all shares available under the 2010 Plan. Since June 30, 2015, all SARs and RSUs granted under the 2010 Plan have vested. At June 30, 2018, there were 796,980 SARs outstanding and exercisable at a weighted average exercise price of $12.74 per share.

 

 

Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income available to common shareholders by the sum of the weighted average number of common shares outstanding and the potential number of dilutive common shares outstanding during the period, excluding the effect of any anti-dilutive securities.

SARs granted by Fly that contain non-forfeitable rights to receive dividend equivalents are deemed participating securities (see Note 12). Net income available to common shareholders is determined by reducing the Company’s net income for the period by dividend equivalents paid on vested SARs during the period.

 

14. COMMITMENTS AND CONTINGENCIES

 

Residual Value Guarantee

 

In 2016, Fly entered into agreements with third-party lessors to guarantee the residual value of three aircraft subject to twelve-year leases (“RVGs”). Fly received residual value guarantee fees totaling $6.6 million, which are being amortized over a twelve-year period. The third-party lessors may exercise their rights under the RVGs by issuing a notice to Fly eleven months before each lease expiry date requiring Fly to purchase the aircraft on such date. The RVGs will terminate if not exercised accordingly. During each of the three and six months ended June 30, 2018 and 2017, Fly recognized $0.1 million and $0.3 million of income, respectively.

 

AirAsia Transactions

 

On February 28, 2018, the Company entered into definitive agreements with respect to the AirAsia Transactions. Under the terms of the agreements, the Company will acquire a portfolio of 33 Airbus A320-200 aircraft and seven engines on operating leases to the AirAsia Group, and one Airbus A320-200 aircraft on operating lease to a third-party airline (“Portfolio A”).  The Company paid a $30.0 million deposit into escrow as security for its obligations under the Portfolio A purchase agreement.  This deposit is recorded on the Company’s balance sheet in “Other assets, net”.  AirAsia will receive approximately $1.0 billion in cash and 3,333,333 common shares newly issued by Fly in the form of ADSs, at a price of $15.00 per share, in consideration for Portfolio A. The common shares acquired by AirAsia will be subject to lock-up arrangements through 2021, and voting and standstill arrangements, and will be entitled to registration rights. (See Note 17.)

 

In addition to the Portfolio A transaction, the Company agreed to acquire 21 Airbus A320neo family aircraft on operating leases to the AirAsia Group as the aircraft deliver between 2019 and 2021 (“Portfolio B”).  The Company also will acquire the option to purchase an additional 20 Airbus A320neo family aircraft, not subject to lease, which begin delivering as early as 2019 (“Portfolio C”).

 

The AirAsia Transactions were approved by AirAsia's shareholders at an extraordinary meeting held on May 14, 2018.

 

15. RELATED PARTY TRANSACTIONS

 

With respect to aircraft financed by the Securitization Notes, BBAM is entitled to receive (i) a rent fee equal to 3.5% of the aggregate amount of rents actually collected, plus $1,000 per aircraft per month and (ii) a sales fee of 1.5% of the aggregate gross proceeds in respect of any aircraft sold. BBAM also is entitled to an administrative agency fee from B&B Air Funding of $20,000 per month, subject to an annual CPI adjustment.

 

With respect to all other aircraft, BBAM is entitled to receive a servicing fee equal to 3.5% of the aggregate amount of rents actually collected, plus an administrative fee of $1,000 per aircraft per month. Under the Term Loan, the Magellan Acquisition Limited Facility, the Fly Acquisition III Facility and the Fly Aladdin Acquisition Facility, BBAM also is entitled to an administrative fee of $10,000 per month. In addition, BBAM is entitled to receive an acquisition fee of 1.5% of the gross acquisition cost for any aircraft purchased and a disposition fee of 1.5% of the gross proceeds for any aircraft sold.

 

For the three and six months ended June 30, 2018, BBAM received servicing and administrative fees totaling $3.7 million and $7.3 million, respectively. For the three and six months ended June 30, 2017, BBAM received servicing and administrative fees totaling $3.2 million and $6.4 million, respectively.

 

During the three and six months ended June 30, 2018, the Company incurred origination fees, payable to BBAM totaling $0.4 million and $1.0 million, respectively. During the three and six months ended June 30, 2017, the Company incurred origination fees, payable to BBAM totaling $4.3 million.

 

During the three and six months ended June 30, 2018, the Company incurred disposition fees of $1.7 million in connection with the sale of two aircraft. The Company did not sell any aircraft during the three and six months ended June 30, 2017.

 

Fly pays an annual management fee to the Manager as compensation for providing the services of the chief executive officer, the chief financial officer and other personnel, and for certain corporate overhead costs related to the Company. The management fee is adjusted each calendar year by (i) 0.3% of the change in the book value of the Company’s aircraft portfolio during the preceding year, up to a $2.0 billion increase over $2.7 billion and (ii) 0.25% of the change in the book value of the Company’s aircraft portfolio in excess of $2.0 billion, with a minimum management fee of $5.0 million. The management fee also is subject to an annual CPI adjustment applicable to the prior calendar year. For the three and six months ended June 30, 2018, the Company incurred management fees of $1.9 million and $3.7 million, respectively. For the three and six months ended June 30, 2017, the Company incurred management fees of $1.6 million and $3.1 million, respectively.

 

16. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Assets and liabilities recorded at fair value on a recurring basis in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair values. The hierarchy levels give the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Fair value measurements are disclosed by level within the following fair value hierarchy:

 

Level 1 — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

 

Level 2 — Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

 

Level 3 — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

 

The Company’s financial instruments consist principally of cash and cash equivalents, restricted cash and cash equivalents, accounts receivable, derivative instruments, accounts payable and borrowings. Fair value of an asset is defined as the price a seller would receive in a current transaction between knowledgeable, willing and able parties. A liability’s fair value is defined as the amount that an obligor would pay to transfer the liability to a new obligor, not the amount that would be paid to settle the liability with the creditor.

 

Where available, the fair value of the Company’s notes payable and debt facilities is based on observable market prices or parameters or derived from such prices or parameters (Level 2). Where observable prices or inputs are not available, valuation models are applied, using the net present value of cash flow streams over the term using estimated market rates for similar instruments and remaining terms (Level 3). These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity. The Company determines the fair value of its derivative instruments using a discounted cash flow model which incorporates an assessment of the risk of non-performance by the swap counterparty and an evaluation of its credit risk in valuing derivative liabilities. The valuation model uses various inputs including contractual terms, interest rate curves, credit spreads and measures of volatility.

 

The Company also measures the fair value for certain assets and liabilities on a non-recurring basis, when GAAP requires the application of fair value, including events or changes in circumstances that indicate that the carrying amounts of assets may not be recoverable. Assets subject to these measurements include Fly’s investment in an unconsolidated subsidiary and flight equipment held for operating lease, net. Fly accounts for its investment in an unconsolidated subsidiary under the equity method and records impairment when its fair value is less than its carrying value and the Company determines that the decline is other-than-temporary (Level 3).

 

The Company records flight equipment at fair value when the carrying value may not be recoverable. Such fair value measurements are based on management’s best estimates and judgment and use Level 3 inputs which include assumptions as to future cash flows associated with the use of an aircraft and eventual disposition of such aircraft. The Company will record an impairment charge if the expected sale proceeds of an aircraft are less than its carrying value. The Company did not record any impairment during the three and six months ended June 30, 2018 or June 30, 2017.

 

The carrying amounts and fair values of the Company’s debt instruments are as follows (dollars in thousands):

As of June 30, 2018 and December 31, 2017, the categorized derivative assets and liabilities measured at fair value on a recurring basis, based upon the lowest level of significant inputs to the valuations are as follows (dollars in thousands):

 

17. SUBSEQUENT EVENTS

 

Subsequent to June 30, 2018, 12 Airbus A320-200 aircraft were transferred in partial completion of the AirAsia Transactions for a total of 13 Airbus A320-200 aircraft from Portfolio A. These aircraft were financed in part by borrowings of $213.4 million under the Fly Aladdin Acquisition Facility, and $16.3 million under the Fly Acquisition III Facility. The remaining 21 Airbus A320-200 aircraft and seven engines in Portfolio A are expected to transfer in the third quarter of 2018.

On July 18, 2018, Fly entered into a subscription agreement (the “AirAsia Subscription Agreement” and, together with the Onex Securities Purchase Agreement and the Summit Securities Purchase Agreement, the “Securities Purchase Agreements”) with AirAsia Group Berhad ("AAGB"), parent company to AirAsia, and AirAsia, pursuant to which Fly will issue 3,333,333 of its common shares in the form of ADSs, valued at $15.00 per share, to AAGB, in connection with the AirAsia Transactions. This transaction is expected to close during the third quarter of 2018. The Fly common shares to be issued to AAGB will be subject to lock-up restrictions until 2021, as well as voting and standstill undertakings until AAGB and its affiliates own less than 10% of Fly’s outstanding shares.  Fly has agreed to register the common shares issued and sold pursuant to the Securities Purchase Agreements for resale with the Securities and Exchange Commission.

 

On July 31, 2018, the Company entered into a recourse secured borrowing in the amount of $122.5 million to finance an unencumbered aircraft. The Company expects to use the loan proceeds to pay-off the CBA Facility and an aircraft secured borrowing.

 

Subsequent to June 30, 2018, the Company sold one Airbus A319-100 aircraft.

 

Item 2.

Management’s Discussion & Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our (i) consolidated financial statements and related notes included elsewhere in this Interim Report and (ii) Annual Report on Form 20-F for the year ended December 31, 2017. The consolidated financial statements have been prepared in accordance with U.S. GAAP and are presented in U.S. dollars. The discussion below contains forward-looking statements that are based upon our current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these expectations due to changes in global, regional or local political, economic, business, competitive, market, regulatory and other factors, many of which are beyond our control. See “Preliminary Note.”

 

Overview

 

Fly Leasing Limited is a Bermuda exempted company that was incorporated on May 3, 2007, under the provisions of Section 14 of the Companies Act 1981 of Bermuda. We are principally engaged in purchasing commercial aircraft, which we lease under multi-year contracts to a diverse group of airlines throughout the world.

 

Although we are organized under the laws of Bermuda, we are a resident of Ireland for tax purposes and are subject to Irish corporation tax on our income in the same way, and to the same extent, as if we were organized under the laws of Ireland.

 

For the three and six months ended June 30, 2018, we had net income of $ 24.3 million and $ 34.0 million or diluted earnings per share of $ 0.87 and $ 1.21 , respectively. Net cash flows provided by operating activities for the six months ended   June 30, 2018 totaled $ 104.8 million. For the six months ended June 30, 2018, n et cash flows provided by investing activities totaled $ 1.3 m illion and net cash flows used in financing activities totaled $96.7 million.

AirAsia Transactions

On February 28, 2018, we entered into definitive agreements with respect to the AirAsia Transactions. Under the terms of the agreements, we will acquire a portfolio of 33 Airbus A320-200 aircraft and seven engines on operating leases to the AirAsia Group, and one Airbus A320-200 aircraft on operating lease to a third-party airline (“Portfolio A”). We paid a $30.0 million deposit into escrow as security for our obligations under the Portfolio A purchase agreement. AirAsia Group Berhad ("AAGB"), parent company to AirAsia, will receive approximately $1.0 billion in cash and 3,333,333 newly issued common shares in the form of ADSs, at a price of $15.00 per share, in consideration for Portfolio A.

 

In addition to the Portfolio A transaction, we agreed to acquire 21 Airbus A320neo family aircraft on operating leases to the AirAsia Group as the aircraft deliver between 2019 and 2021 (“Portfolio B”). We also will acquire the option to purchase an additional 20 Airbus A320neo family aircraft, not subject to lease, which begin delivering as early as 2019 (“Portfolio C”).

 

The AirAsia Transactions were approved by AirAsia's shareholders at an extraordinary meeting held on May 14, 2018.

 

As of August 23, 2018, a total of 13 Airbus A320-200 aircraft in Portfolio A have been transferred. The remaining 21 Airbus A320-200 aircraft and seven engines in Portfolio A are expected to transfer in the third quarter of 2018.

 

In connection with the AirAsia Transactions, on July 13, 2018, we issued and sold a total of 1,333,334 of our common shares in the form of ADSs, at a purchase price of $15.00 per share, to affiliates of Onex Corporation and members of the management team of BBAM LP in private placement transactions, for aggregate proceeds of $20.0 million. In addition, on July 18, 2018, we entered into a subscription agreement with AAGB, parent company to AirAsia, and AirAsia, pursuant to which we will issue 3,333,333 of our common shares in the form of ADSs, valued at $15.00 per share, to AAGB, in connection with the AirAsia Transactions. This transaction is expected to close during the third quarter of 2018. All of our common shares held by Onex, and our newly issued common shares held by members of the management team of BBAM LP, are subject to a 180-day lock-up from the date of issuance. Our common shares to be issued to AAGB will be subject to lock-up restrictions until 2021, as well as voting and standstill undertakings until AAGB and its affiliates own less than 10% of our outstanding shares. We have agreed to register the common shares described above for resale with the Securities and Exchange Commission.

 

Market Conditions

 

The airline industry has been profitable every year since 2012 and airline profitability is expected to continue in 2018 amid strengthening global economic activity. Global passenger air traffic grew by 7.6% in 2017 and load factors were at record levels for the year. Although at a slightly slower pace, the upward trend in passenger volume has continued in 2018. Further, utilization remains strong and the parked fleet is steady at less than 4% for aircraft under 20 years old. Competition remains strong in the sale lease-back market and aircraft values generally remain stable.

 

Long term, we believe the overall positive trends in world air traffic and demand for commercial aircraft will continue to drive growth in the aircraft leasing market. Aircraft manufacturers are increasing the production rates of their narrow-body aircraft and certain of their wide-body aircraft, as airlines continue to transition to new models.

Despite the favorable market conditions, the airline industry is cyclical, and macroeconomic, geopolitical and other risks may negatively impact airline profitability or create unexpected volatility in the aircraft leasing market. Although we expect the overall airline industry to remain profitable, profits are not uniformly distributed among airlines, and certain airlines, particularly smaller airlines and start-up carriers, may struggle financially. These lessees may be unable to make lease rental and other payments on a timely basis. In addition, an increase in new aircraft production rates by aircraft manufacturers may reduce the demand for used aircraft, leading to a reduction in the lease rates and the values of used aircraft, or may create a condition of oversupply should demand falter.

 

Critical Accounting Policies and Estimates

 

Fly prepares its consolidated financial statements in accordance with U.S. GAAP, which requires the use of estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The use of estimates is a significant factor affecting the reported carrying values of flight equipment, investments, deferred assets, accruals and reserves. We utilize third party appraisers and industry valuation professionals, where possible, to support estimates, particularly with respect to flight equipment. Despite our best efforts to accurately estimate such amounts, actual results could differ from those estimates. We have made no significant changes in our critical accounting policies and significant estimates from those disclosed in our Annual Report on Form 20-F for the year ended December 31, 2017.

 

 

As of June 30, 2018 , we had 85 aircraft in our portfolio, 84 of which were held for operating lease, and one was recorded as an investment in finance lease . As of June 30, 2017 , we had 81 aircraft in our portfolio, of which 80 were held for operating lease and one was recorded as an investment in finance lease.

 

For the three months ended June 30, 2018, operating lease revenue totaled $99.3 million, an increase of $20.1 million compared to the three months ended June 30, 2017. The increase was primarily due to (i) recognition of end of lease income totaling $12.6 million in 2018, (ii) an increase of $11.9 million from aircraft purchased in 2017 and 2018, and (iii) an increase of $1.5 million related to leases with floating rate rents. The increase was partially offset by (i) a decrease of $2.6 million from lower lease rates on lease extensions and remarketings, (ii) a decrease of $2.7 million in lease revenue from aircraft sold in 2017 and 2018, and (iii) an increase of $0.5 million in amortization of lease incentives, lease discounts and other.

 

Equity loss from unconsolidated subsidiary was $0.4 million for the three months ended June 30, 2018, compared to equity earnings of $0.1 million for the three months ended June 30, 2017. During the second quarter of 2018, Fly Z/C LP entered into an agreement to sell the aircraft associated with its finance lease receivable, in connection with which we recorded an impairment of this asset.

 

During the three months ended June 30, 2018, we sold two aircraft and recognized a gain on sale of aircraft of $2.9 million. We did not sell any aircraft during the three months ended June 30, 2017.

 

Depreciation expense during the three months ended June 30, 2018 was $33.9 million, compared to $33.1 million for the three months ended June 30, 2017, an increase of $0.8 million. The increase was primarily due to depreciation on aircraft acquired in 2017 and 2018. This increase was partially offset by a reduction in depreciation on aircraft sold in 2017 and 2018.

 

Interest expense totaled $33.6 million and $31.9 million for the three months ended June 30, 2018 and 2017, respectively. The increase of $1.7 million was primarily due to additional secured borrowings and increases in LIBOR. This increase was partially offset by a reduction in interest due to debt repayments and refinancings which lowered the applicable interest rate on the refinanced debt.

 

Selling, general and administrative expenses were $6.4 million and $8.0 million for the three months ended June 30, 2018 and 2017, respectively. The decrease of $1.6 million was primarily due to an unrealized foreign exchange gain of $0.9 million during the three months ended June 30, 2018, compared to an unrealized foreign exchange loss of $1.3 million during the three months ended June 30, 2017. This decrease was partially offset by an increase of $0.7 million in servicing and management fees paid to BBAM due to the growth in the aircraft portfolio.

 

For the three months ended June 30, 2018, we recognized a gain on derivatives of $1.3 million compared to a loss of $0.4 million for the three months ended June 30, 2017. During the three months ended June 30, 2018, we recognized a gain of $1.2 million associated with the mark-to-market of interest rate swaps which were not designated as accounting hedges.

 

Debt extinguishment costs totaled $0.9 million and $1.9 million for the three months ended June 30, 2018 and 2017, respectively. The debt extinguishment costs incurred during the three months ended June 30, 2018 were due to debt payoffs associated with aircraft sales. During the three months ended June 30, 2017, we wrote off $1.4 million of unamortized loan costs and debt discounts as debt extinguishment costs in connection with the amendment of the Term Loan in April 2017.

 

Provision for income taxes was $3.9 million and $0.9 million for the three months ended June 30, 2018 and 2017, respectively. We are a tax resident in Ireland and expect to pay the corporation tax rate of 12.5% on trading income and 25.0% on non-trading income. Our effective tax rate was 13.8% and 24.7% for the three months ended June 30, 2018 and 2017, respectively. The difference between the statutory and effective tax rate in each period is primarily attributable to changes in valuation allowances and the amount of income earned by us in different tax jurisdictions.

 

Consolidated Statements of Income for the six months ended June 30, 2018 and 2017