Notes to Consolidated Financial Statements 

For the six months ended June 30, 2015

1. ORGANIZATION

Fly Leasing Limited (the “Company” or “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. The Company was formed to acquire, finance, lease and sell commercial jet aircraft directly or indirectly through its subsidiaries.

Although the Company 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 the Company were organized under the laws of Ireland.

In accordance with the Company’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 the Company’s amended and restated bye-laws, the Manager Shares have the right to appoint the nearest whole number of directors to the Company 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 the Company’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. The Company 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, Fly will consolidate a Variable Interest Entity (“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 has one operating and reportable segment which is aircraft leasing.

Certain amounts in prior period consolidated financial statements have been reclassified to conform to the current period presentation. Such reclassifications have no impact on consolidated net income or shareholders’ equity.

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, accruals 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.

FLIGHT EQUIPMENT HELD FOR SALE

In accordance with guidance provided by the Financial Accounting Standards Board (“FASB”), flight equipment is classified as held for sale when the Company commits to and commences a plan of sale that is reasonably expected to be completed within one year and satisfies certain other held for sale criteria. Flight equipment held for sale is recorded at the lesser of carrying value or fair value, less estimated cost to sell. An impairment loss is recorded for an asset or asset group held for sale when the carrying value of the asset or asset group exceeds its fair value, less estimated cost to sell. An aircraft classified as held for sale will not depreciate.

Subsequent changes to the asset’s fair value are recorded as adjustments to the carrying value of the flight equipment. However, any such adjustment will not exceed the original carrying value of the flight equipment held for sale.

NEW ACCOUNTING PRONOUNCEMENTS

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) . ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenues arising from contracts with customers. The guidance specifically notes that lease contracts with customers are a scope exception. ASU 2014-09 is effective for annual reporting periods (including interim periods), beginning after December 15, 2016, and early adoption is not permitted. The Company will adopt the guidance effective January 1, 2017. The Company anticipates that the adoption of the standard will not have a material effect on its consolidated financial condition, result of operations or cash flows.

In August 2014, FASB issued ASU 2014-15, update to Accounting Standards Codification (ASC) subtopic 250-40, Presentation of Financial Statements-Going Concern . The amendments require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in the U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term “substantial doubt”, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). ASU 2014-15 is effective for annual reporting periods (including interim periods) ending after December 15, 2016, and early adoption is permitted. The Company will adopt the guidance effective January 1, 2017.

In February 2015, FASB issued ASU 2015-02, which amends ASC 810 , Consolidation . The amendment significantly changes the consolidation analysis required under U.S. GAAP and could have a significant impact on the consolidation conclusions of the reporting entity. ASU 2015-02 is effective for annual reporting periods (including interim periods), beginning after December 15, 2015. Early adoption is permitted. The Company will adopt the guidance effective January 1, 2016. The Company is currently assessing the impact on its consolidated financial statements and notes to its consolidated financial statements.

In April 2015, FASB issued ASU 2015-03, Interest - Imputation of Interest , which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with the accounting treatment for debt discounts. The recognition and measurement guidance of debt issuance costs are not affected by this update. The guidance, which requires retrospective application, will be adopted by the Company effective January 1, 2016.

3. FLIGHT EQUIPMENT HELD FOR SALE

On June 19, 2015, the Company contracted to sell a portfolio of 33 aircraft to ECAF I Ltd. (the “Purchaser”) for approximately $985.0 million, subject to adjustment based on rents in respect of certain of the aircraft (the “ECAF-I Transaction”). The sale agreement provides for delivery of the aircraft to the Purchaser over a period of 270 days from the date of the sale agreement, subject to customary closing conditions.

The Company concluded that the ECAF-I Transaction does not qualify as discontinued operations since the sale does not represent a strategic shift in its operations. As of June 30, 2015, the Company had 33 aircraft held for sale with a total net book value of $933.7 million. There was no flight equipment held for sale as of December 31, 2014.

4. FLIGHT EQUIPMENT HELD FOR OPERATING LEASE, NET

As of June 30, 2015, the Company had 96 aircraft held for operating lease. Of these aircraft, 91 were on lease to 49 lessees in 30 countries, and five aircraft were off-lease. Two of the aircraft off-lease were subject to sale agreements. As of December 31, 2014, the Company had 127 aircraft held for operating lease. Of these aircraft, 124 were on lease to 64 lessees in 36 countries, and three aircraft were off-lease.

During the six month period ended June 30, 2015, the Company purchased five aircraft for a total cost of $176.4 million. During the six month period ended June 30, 2014, the Company purchased 11 aircraft for a total cost of $308.0 million.

During the six month period ended June 30, 2015, the Company sold three aircraft and recognized a pre-tax gain of $1.9 million. During the three and six month periods ended June 30, 2014, the Company sold seven aircraft, five of which generated a pre-tax gain of $18.9 million. The Company recorded a gain on debt extinguishment of $4.0 million in connection with the sale of the other two aircraft.

The Company evaluates flight equipment for impairment when circumstances indicate that the carrying amount of such asset may not be recoverable. The review for recoverability includes an assessment of the estimated future cash flows associated with the use of an asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the Company will assess whether the carrying value of the flight equipment exceeds the fair value and an impairment loss is required. The undiscounted cash flows is the sum of the current contracted lease rates, future projected lease rates, transition costs, estimated down time and estimated residual or scrap values for an aircraft. The Company will also record an impairment charge if the expected sale proceeds of an aircraft are less than its carrying value. The impairment loss is measured as the excess of the carrying amount over the fair value of the impaired asset.

During the three and six month periods ended June 30, 2015, the Company recognized aircraft impairment of $65.4 million. The impairment charge related to three wide-body aircraft nearing the end of their economic lives and 13 narrow-body aircraft. The Company did not recognize aircraft impairment for the corresponding periods in 2014.

As of June 30, 2015 and December 31, 2014, flight equipment held for operating lease, net, consisted of the following:

The Company capitalized $9.0 million and $5.5 million of major maintenance expenditures for the six month periods ended June 30, 2015 and 2014, respectively. Of the amount capitalized in 2015, $3.1 million was included in flight equipment held for operating lease, net, and $5.9 million was included in flight equipment held for sale. The amount capitalized in 2014 was included in flight equipment held for operating lease, net.

The classification of the net book value of flight equipment held for operating lease, net, and operating lease revenues 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, net, by geographic region is as follows:

  The distribution of operating lease revenue by geographic region for the three month periods ended June 30, 2015 and 2014 is as follows:

The distribution of operating lease revenue by geographic region for the six month periods ended June 30, 2015 and 2014 is as follows:

The Company had one customer that accounted for 10% or more of total operating lease revenue for the three and six month periods ended June 30, 2015. The Company had no customer that accounted for 10% or more of total operating lease revenue for the three or six month periods ended June 30, 2014. During the three and six month periods ended June 30, 2015, the Company had three lessees and four lessees, respectively, on non-accrual status due to concerns about each lessee’s financial condition and only recognized revenue as cash was received. The Company recognized rental revenue of $0.8 million and $2.8 million from these lessees during the three and six month periods ended June 30, 2015, respectively. During the three and six month periods ended June 30, 2014, the Company had one lessee on non-accrual status. The Company recognized rental revenue of $0.5 million and $0.9 million from this lessee during the three and six month periods ended June 30, 2014, respectively.

For the three and six month periods ended June 30, 2015, the Company recognized end of lease revenue totaling $3.7 million and $25.6 million, respectively. For the three and six month periods ended June 30, 2014, the Company recognized end of lease revenue totaling $0.2 million and $3.9 million, respectively.

The amortization of lease premiums, net of lease discounts, which have been included as a component of operating lease revenue, was $0.4 million and $1.1 million for the three and six month periods ended June 30, 2015, respectively. Amortization of lease premiums, net of lease discounts, was $0.7 million and $1.7 million for the three and six month periods ended June 30, 2014, respectively.

The amortization of lease incentives recorded as a reduction of operating lease revenue totaled $4.8 million and $8.8 million for the three and six month periods ended June 30, 2015, respectively. The amortization of lease incentives totaled $3.8 million and $7.2 million for the three and six month periods ended June 30, 2014, respectively.

As of each of June 30, 2015 and December 31, 2014, the weighted average remaining lease term of the Company’s flight equipment held for operating lease, net, was 5.2 years.

5. INVESTMENT IN UNCONSOLIDATED SUBSIDIARY

Investment in Fly-Z/C LP

The Company has a 57.4% limited partnership interest in Fly-Z/C LP. Summit Aviation Partners LLC has a 10.2% interest in the joint venture and the limited partners appointed a subsidiary of BBAM LP as the general partner. For the three and six month periods ended June 30, 2015, the Company recognized $0.3 million and $0.7 million, respectively, in equity earnings from its investment in Fly-Z/C LP. For the three and six month periods ended June 30, 2014, the Company recognized $0.4 million and $1.7 million, respectively, in equity earnings from its investment in Fly-Z/C LP. The Company’s equity earnings in 2014 included its share of the gain recognized by Fly-Z/C LP on the conversion of two operating leases to finance leases. These two aircraft were transferred to the lessee at lease expiry during the first quarter of 2015. There are two aircraft remaining in the joint venture. The Company received no distributions during the six month period ended June 30, 2015. During the six month period ended June 30, 2014, the Company received distributions of $6.6 million.

On December 11, 2013, the Company sold $300.0 million aggregate principal amount of unsecured 6.75% Senior Notes due 2020 (together with the Additional 2020 Notes (as defined below), the “2020 Notes”). In connection with the issuance, the Company paid an underwriting discount totaling $8.5 million.

On October 3, 2014, the Company sold $75.0 million aggregate principal amount of unsecured 6.75% Senior Notes due 2020 (the “Additional 2020 Notes”) and $325.0 million aggregate principal amount of 6.375% Senior Notes due 2021 (the “2021 Notes”). The Additional 2020 Notes were issued as additional notes under the 2020 Notes indenture, and were sold at a price of 104.75% of the principal amount thereof. The 2021 Notes were issued under an indenture containing substantially similar terms as the indenture governing the 2020 Notes and were sold at par. The Company received net cash proceeds of $396.6 million after deducting the underwriting discounts.

The 2020 Notes and 2021 Notes are unsecured obligations of the Company and rank pari passu in right of payment with any existing and future senior indebtedness of the Company. The 2020 Notes have a maturity date of December 15, 2020 and the 2021 Notes have a maturity date of October 15, 2021.

Interest on the 2020 Notes is payable semi-annually on June 15 and December 15 of each year. As of each of June 30, 2015 and December 31, 2014, accrued interest on the 2020 Notes totaled $1.1 million. Interest on the 2021 Notes is payable semi-annually on April 15 and October 15 of each year, beginning on April 15, 2015. As of June 30, 2015 and December 31, 2014, accrued interest on the 2021 Notes totaled $4.4 million and $5.1 million, respectively.

Pursuant to the indentures governing the 2020 Notes and the 2021 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. Certain of these covenants will be suspended if the 2020 Notes or 2021 Notes obtain an investment grade rating.

The indentures governing the 2020 Notes and 2021 Notes contain customary events of default with respect to each series. As of June 30, 2015, the Company was not in default under the indentures governing the 2020 Notes or the 2021 Notes.

The Company is subject to restrictive covenants under its secured borrowings including, among other things:

The Company’s failure to comply with any of these covenants may trigger an event of default under the relevant loan or facility agreement. Certain of the Company’s loan agreements also contain cross-default provisions that could be triggered by a default under another loan agreement.

Generally, events of default under the Company’s loan or facility agreements include, among other things:

As of June 30, 2015, the Company was not in default under any of its secured borrowings.

On October 2, 2007, concurrently with the Company’s initial public offering, B&B Air Funding issued $853.0 million of aircraft lease-backed Class G-1 notes (the “Securitization Notes”). The Securitization Notes are direct obligations of B&B Air Funding and are not obligations of, or guaranteed by Fly. At June 30, 2015, 35 aircraft were financed by the Securitization Notes, 20 of which were subject to sale agreements that are expected to be consummated in 2015. The final maturity date of the Securitization Notes is November 14, 2033.

The Securitization Notes bear interest at an adjustable interest rate equal to the then-current one-month LIBOR plus 0.77%. Interest expense also includes amounts payable to the policy provider and the liquidity facility provider thereunder, as well as accretion on the Securitization Notes re-issued at a discount. The Company has entered into interest rate swap contracts to mitigate the interest rate fluctuation risk associated with a portion of the Securitization Notes. As of each of June 30, 2015 and December 31, 2014, accrued interest on the Securitization Notes totaled $0.2 million.

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 the fees to the policy provider, interest and interest rate swap payments in accordance with those agreements. Principal payments during the six month periods ended June 30, 2015 and 2014 totaled $34.0 million and $25.0 million, respectively.

The Company assumed a debt facility (the “Nord LB Facility”) provided by Norddeutsche Landesbank Gironzentrale (“Nord LB”) that financed 19 of the aircraft in the GAAM Portfolio. The Nord LB Facility is structured as individual loans with each aircraft owning subsidiary acting as the borrower of its respective loan. The loans are cross-collateralized and contain cross-default provisions. As of June 30, 2015, the Nord LB Facility provided financing for 17 aircraft, four of which were subject to a sale agreement that is expected to be consummated in 2015. During the six month periods ended June 30, 2015 and 2014, the Company made total principal payments of $16.3 million and $19.0 million, respectively, under the Nord LB Facility.

The loans under the Nord LB Facility bear interest at one-month LIBOR plus 3.30% until the final maturity date of November 14, 2018. To mitigate our exposure to interest rate fluctuations, the Company has entered into interest rate swap contracts. As of each of June 30, 2015 and December 31, 2014, the blended weighted average interest rate for the facility was 4.15%, excluding the debt discount amortization. As of each of June 30, 2015 and December 31, 2014, interest accrued on the facility totaled $0.7 million.

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, no payment is due under the loan associated with that aircraft during such period. Any unpaid interest increases the outstanding borrowing.  

The Nord LB Facility does not contain any financial covenants.

The Company assumed a debt facility provided by Bank of Scotland plc, Commonwealth Bank of Australia and CommBank Europe Limited (together, “CBA”) (the “CBA Facility”) that financed 21 of the aircraft in the GAAM Portfolio. As of June 30, 2015, the CBA Facility provided for individual loans on seven aircraft, two of which were subject to a sale agreement that is expected to be consummated in 2015. These loans are cross-collateralized and contain cross-default provisions. One loan matures in 2018, and the remaining six loans mature in 2020. Fly has guaranteed all payments under the CBA Facility.

The Company makes scheduled monthly payments of principal and interest on each loan in accordance with a fixed amortization schedule. During the six month periods ended June 30, 2015 and 2014, the Company made total principal payments of $5.5 million and $5.9 million, respectively.

Borrowings under the CBA Facility accrue interest at either a fixed or variable interest rate. Variable borrowings bear interest based on one-month LIBOR, plus an applicable composite margin of 2.50%. As of June 30, 2015 and December 31, 2014, the weighted average interest rates on the tranche loans, excluding the debt discount amortization, are presented below:

As of June 30, 2015 and December 31, 2014, interest accrued on the facility totaled $28,000 and $44,000, respectively.

There are no financial covenants in the CBA Facility.

On August 9, 2012, the Company entered into a $395.0 million senior secured term loan (the “Term Loan”) with a consortium of lenders. On November 21, 2013, the Company amended and upsized the Term Loan by $105.0 million. On April 22, 2015, the Company re-priced the Term Loan, reducing the interest rate margin from 3.50% to 2.75% and the LIBOR floor from 1.00% to 0.75%. As of June 30, 2015, the Term Loan was secured by 29 aircraft, three of which were subject to a sale agreement that is expected to be consummated in 2015. The Term Loan matures in August 2019.

Until April 2016, the Term Loan can be prepaid in whole or in part for an amount equal to 101% of the outstanding principal amount being repaid. Thereafter, the Term Loan can be repaid in whole or in part at par.

In connection with the April 2015 re-pricing, the Company wrote-off approximately $2.1 million of unamortized loan costs and debt discounts as debt extinguishment costs. There was no prepayment penalty associated with the re-pricing. All other terms and conditions of the Term Loan remain the same.

As of June 30, 2015 and December 31, 2014, interest accrued on the Term Loan totaled $2.2 million and $2.9 million, respectively. The Term Loan requires quarterly principal payments of $5.9 million. Fly has guaranteed all payments under the Term Loan.

Fly Acquisition II Facility

The Company entered into a revolving credit facility with a consortium of lenders (“Fly Acquisition II Facility”) providing loans in an aggregate amount of up to $450.0 million with an availability period expiring on July 3, 2015 and a final maturity date of July 3, 2018. During the first quarter of 2015, the Company made principal payments of $4.3 million.

The Company paid a commitment fee of 0.75% per annum on a monthly basis to each lender on the undrawn amount of its commitment until January 2015 when the Company exercised its right to terminate the availability period. The interest rate under the facility was based on one-month LIBOR plus an applicable margin. Following termination of the availability period, the applicable margin was increased from 3.25% to 3.75%. During the first quarter of 2015, the Company terminated the Fly Acquisition II Facility and repaid $117.3 million outstanding with proceeds from the sale of three aircraft and the refinancing of one aircraft that was financed under the Fly Acquisition II Facility. The Company wrote-off approximately $4.0 million of unamortized loan costs as debt extinguishment costs. There was no prepayment penalty in connection with the termination of the Fly Acquisition II Facility.

As of December 31, 2014, the interest accrued on the Fly Acquisition II Facility totaled $0.2 million.

In addition to the debt financings described above, the Company has entered into other aircraft secured borrowings to finance the acquisition of aircraft. These borrowings may finance the acquisition of one or more aircraft and are usually structured as individual loans that are secured by pledges of the Company’s rights, title and interest in the financed aircraft and leases. The maturity date on each loan generally matches the corresponding lease expiration date, with maturity dates ranging from December 2015 to January 2027. The Company makes scheduled monthly payments of principal and interest on each loan in accordance with a fixed amortization schedule. During the six month periods ended June 30, 2015 and 2014, principal payments totaled $28.6 million and $19.1 million, respectively.

As of June 30, 2015, 26 aircraft were financed by these other aircraft secured borrowings, five of which were subject to a sale agreement that is expected to be consummated in 2015. At June 30, 2015 and December 31, 2014, $557.7 million and $425.0 million of the principal amount of other aircraft secured borrowings, respectively, were recourse to the Company. As of each of June 30, 2015 and December 31, 2014, interest accrued on these loans totaled $1.1 million.

During the six month period ended June 30, 2015, the Company acquired one aircraft with a combination of unrestricted cash and proceeds from secured, recourse debt financing of $36.0 million. In addition, the Company refinanced four aircraft with new secured, recourse debt of $113.4 million.

The Company has one other aircraft secured borrowing that is denominated and required to be paid in Euros. During the three month period ended June 30, 2015, the Company recorded an unrealized foreign currency exchange loss of $0.9 million, resulting from a decrease of the U.S. Dollar value relative to the Euro. During the six month period ended June 30, 2015, the Company recorded an unrealized foreign currency exchange gain of $1.1 million resulting from an increase of the U.S. Dollar value relative to the Euro.

8. DERIVATIVES

Derivatives are used by the Company to manage its exposure to interest rate and foreign currency exchange fluctuations. The Company uses interest rate swap contracts to hedge variable interest payments due on loans associated with aircraft with fixed rate rentals. As of June 30, 2015, the Company’s total unsecured and secured debt balance, excluding unamortized debt discount, was $3.0 billion. Debt with floating interest rates totaled $2.0 billion, of which $1.5 billion was 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 the one-month and three-month LIBOR on the notional amounts over the life of the contracts. As of June 30, 2015 and December 31, 2014, the Company had interest rate swap contracts with notional amounts aggregating $1.3 billion and $1.4 billion, respectively. The unrealized fair value gain on the interest rate swap contracts, reflected as derivative assets, was $0.5 million and $2.1 million as of June 30, 2015 and December 31, 2014, respectively. The unrealized fair value loss on the interest rate swap contracts, reflected as derivative liabilities, was $21.1 million and $23.3 million as of June 30, 2015 and December 31, 2014, respectively.

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, credit spreads and measures of volatility.

Designated Derivatives

The Company’s 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. For the three and six month periods ended June 30, 2015, the Company recorded a net unrealized gain of $3.9 million and a net unrealized loss of $2.0 million, after the applicable net tax expense of $0.7 million and net tax benefit of $0.2 million, respectively. For the three and six month periods ended June 30, 2014, the Company recorded net unrealized losses of $5.5 million and $6.3 million, after the applicable net tax benefits of $0.8 million and $0.9 million, respectively.

As of June 30, 2015, the Company had the following designated derivative instruments classified as derivative assets on the balance sheet (dollar amounts in thousands):

As of June 30, 2015, the Company had the following designated derivative instruments classified as derivative liabilities on the balance sheet (dollar amounts in thousands):

Dedesignated Derrivatives

During the second quarter of 2015, certain of the Company’s interest rate derivatives no longer qualified for cash flow hedge accounting. The associated accumulated other comprehensive loss was reclassified into earnings during each of the three and six month periods ended June 30, 2015.

Terminated Derivatives

During the first quarter of 2015, the Company terminated five interest rate swap contracts in connection with the termination of the Fly Acquisition II Facility and received settlement proceeds totaling $23,000. The gain recognized into earnings associated with the terminated interest rate swap contracts totaled $0.1 million.

9. SHARE-BASED COMPENSATION

On April 29, 2010, the Company adopted the 2010 Omnibus Incentive Plan (“2010 Plan”) and reserved 1,500,000 shares for issuance under the 2010 Plan. The 2010 Plan permitted the grant of (i) SARs; (ii) RSUs; (iii) nonqualified stock options; and (iv) other stock-based awards. The Company has issued 1,500,000 shares and no shares remain available for grant.

The Company’s outstanding and exercisable SARs is presented below:

The Company’s outstanding and unvested RSUs is presented below:

No SARs or RSUs were granted, exercised, canceled or forfeited during the six month period ended June 30, 2015.

Valuation Assumptions

The Company uses the Black-Scholes option pricing model to determine the fair value of SARs. The fair value of SARs expected to vest is estimated on the date of grant, or if applicable, on the measurement date using the following assumptions:

Share-based compensation expense related to SARs and RSUs is recorded as a component of selling, general and administrative expenses, and totaled $43,000 and $0.2 million for the three and six month periods ended June 30, 2015, respectively. Share-based compensation expense totaled $20,000 and a reversal of $36,000 due to forfeitures for the three and six month periods ended June 30, 2014, respectively. At June 30, 2015, all RSUs and SARs granted were vested. Unamortized share-based compensation expense totaled $0.1 million at December 31, 2014.

10. INCOME TAXES

Fly is a tax resident of Ireland and has wholly-owned subsidiaries in Ireland, France, Luxembourg, Australia, Singapore and Labuan 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. Under current tax rules in Ireland, the Company is allowed to carry forward its net operating losses for an indefinite period to offset any future income. In calculating net trading income, Fly and its Irish tax resident subsidiaries are entitled to a deduction for trading expenses and tax depreciation on their aircraft.

Fly’s Australian resident subsidiaries pay a corporation tax of 30.0% and Fly’s French resident subsidiaries pay a corporation tax of 33.33% on their taxable income. Repatriated earnings and any undistributed earnings from the Company’s Cayman subsidiary will be taxed at the 25.0% tax rate.

Income tax expense (benefit) by jurisdiction is shown below:

The Company had no unrecognized tax benefits as of June 30, 2015 and December 31, 2014.

11. SHAREHOLDERS’ EQUITY

On May 6, 2015, the Company’s Board of Directors approved a $30.0 million share repurchase program expiring in May 2016 to replace a program that expired in May 2015. Under this program, the Company may make share repurchases from time to time in the open market or in privately negotiated transactions. The timing of the repurchases under this program will depend upon a variety of factors, including market conditions, and the program may be suspended or discontinued at any time.

No shares were repurchased during the six month periods ended June 30, 2015 or 2014. As of June 30, 2015, there were 41,469,073 shares outstanding.

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 and RSUs granted by the Company that contain non-forfeitable rights to receive dividend equivalents are deemed participating securities (see Note 9). Net income available to common shareholders is determined by reducing the Company’s net income for the period by dividend equivalents paid on vested RSUs and SARs for the period.

13. COMMITMENTS AND CONTINGENCIES

From time to time, the Company contracts with third-party service providers to perform maintenance or overhaul activities on its off-lease aircraft.

As of June 30, 2015, the Company had commitments to sell 41 aircraft that are expected to be consummated in 2015. 

14. RELATED PARTY TRANSACTIONS

Fly has no employees and has outsourced the daily operations of the Company by entering into management, servicing and administrative agreements (the “Agreements”) with BBAM. Services to be rendered under the Agreements include acquiring and disposing of aircraft; marketing of aircraft for lease and re-lease; collecting rent and other payments from the lessees; monitoring maintenance, insurance and other obligations under the leases; enforcing the Company’s rights under the lease terms; and maintaining the books and records of the Company and its subsidiaries. The Manager manages the Company under the direction of its chief executive officer and chief financial officer. Pursuant to the terms of the Agreements, certain fees and expenses that may be payable to the Manager may be reduced for any like payments made to other BBAM affiliates.

BBAM received base and rent fees pursuant to the Agreements in amounts totaling $3.9 million and $7.7 million for the three and six month periods ended June 30, 2015, respectively. For the three and six month periods ended June 30, 2014, base and rent fees incurred totaled $3.4 million and $6.8 million, respectively. BBAM also received administrative fees from aircraft owning subsidiaries of the Company totaling $0.5 million and $1.1 million during the three and six month periods ended June 30, 2015, respectively. During the three and six month periods ended June 30, 2014, BBAM received administrative fees of $0.5 million and $1.0 million, respectively.

During the three and six month periods ended June 30, 2015, the Company incurred $0.5 million and $2.5 million of origination fees, of which $0.5 million and $1.0 million, respectively, were expensed. With respect to aircraft acquired in the first quarter of 2014, the Manager waived the origination fees that it was entitled to receive from the Company. During the three and six month periods ended June 30, 2014, the Company incurred $3.4 million of origination fees, of which $2.8 million was expensed. During the six month period ended June 30, 2015, the Company incurred $2.0 million of fees in connection with the sale of aircraft. During the three and six month periods ended June 30, 2014, fees of $1.9 million were incurred for aircraft dispositions.

Prior to June 30, 2015, the Company made quarterly payments of $2.5 million, subject to an annual adjustment tied to the Consumer Price Index applicable to the prior calendar year, 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 (“Management Expenses”). The amount is subject to adjustment by notice from the Manager and the approval of the independent members of the Company’s board of directors. For the three and six month periods ended June 30, 2015, the Company incurred Management Expenses of $2.7 million and $5.4 million, respectively. For the three and six month periods ended June 30, 2014, the Company incurred Management Expenses of $2.7 million and $5.3 million, respectively.

On June 19, 2015, in connection with the ECAF-I Transaction, the Company and the Manager agreed to amend the Company’s management agreement (the “Management Agreement”). Pursuant to the amendment, the annual management fee that the Company pays to the Manager was reduced from $10.7 million to $5.7 million, effective as of July 1, 2015. The management fee will be 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 the book value of the post-ECAF-I Transaction portfolio 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 annual management fee of $5.0 million. The management fee also will be subject to an annual adjustment tied to the Consumer Price Index. The term of the Management Agreement has been extended from December 28, 2022 to July 1, 2025.

Also, pursuant to the amendment, the Company and the Manager agreed to reduce the disposition fee that the Company will pay to the Manager in connection with the ECAF-I Transaction. Whereas the Company generally pays a disposition fee of 1.5% of the aggregate gross proceeds in respect of dispositions, the amendment provides that in respect of the ECAF-I Transaction, the aggregate disposition fee will be 1.2% of the aggregate gross proceeds.

In connection with its services, the Manager may incur expenses such as travel, insurance and other professional fees on behalf of the Company. The Company had $0.6 million and $0.3 million of reimbursable expenses due to the Manager as of June 30, 2015 and December 31, 2014, respectively.

15. FAIR VALUE MEASUREMENTS

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.

The fair value of the Company’s cash and cash equivalents, restricted cash and cash equivalents, accounts receivable, and accounts payable approximate their carrying value. (The fair values of cash, restricted cash and cash equivalents are a Level 1 hierarchy. The fair values of accounts receivable and accounts payable are Level 2 hierarchy.) Where available, the fair value of the Company’s notes payable and debt facilities are 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 Fly’s 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 (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 uses 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 also record an impairment charge if the expected sale proceeds of an aircraft are less than its carrying value. During each of the three and six month periods ended June 30, 2015, the Company recognized aircraft impairment totaling $65.4 million. The Company did not recognize aircraft impairment for the corresponding periods in 2014.

The carrying amounts and fair values of the Company’s financial instruments are as follows:

As of June 30, 2015 and December 31, 2014, the categorized asset and liabilities measured at fair value on a recurring basis, based upon the lowest level of significant inputs to the valuations are as follows:

16. SUBSEQUENT EVENTS

On July 15, 2015, the Company declared a dividend of $0.25 per share, or approximately $10.4 million, which will be paid on August 20, 2015 to shareholders of record at July 31, 2015.

In July 2015, the Company sold one Boeing 757-200 aircraft and one Airbus A321-200 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, 2014. 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 month periods ended June 30, 2015, we had net losses of $58.3 million and $41.0 million, or diluted loss per share of $1.42 and $1.00, respectively. Net cash flows provided by operating activities for the six month period ended June 30, 2015 totaled $121.3 million. Net cash flows used in investing activities totaled $49.2 million and net cash flows used in financing activities totaled $59.2 million for the six month period ended June 30, 2015. We paid $21.4 million in dividends and dividend equivalents during the six month period ended June 30, 2015.

Market Conditions

The airline industry has been profitable every year since 2012, with profits each year exceeding the last. It is predicted that airline profitability in 2015 will exceed that of 2014. In addition, oil prices have fallen significantly in 2015, resulting in lower jet fuel prices and positively impacting airline profitability.

There are overall positive trends in world air traffic and demand for commercial aircraft, which we believe will continue to drive growth in the aircraft leasing market. Passenger demand is robust, and aircraft manufacturers have increased their production rates to meet demand for commercial aircraft. Currently, leased aircraft make up approximately 40% of the worldwide commercial jet aircraft fleet that is in service and this percentage is generally expected to be maintained or to increase over time.

However, 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. Moreover, although we expect the airline industry to be profitable in 2015, profits are not uniformly distributed among airlines and certain airlines, particularly smaller airlines and start-up carriers, 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, and could lead to a reduction in the lease rates and the values of used aircraft.

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. Other than as set forth in this Interim Report, 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, 2014.

Flight Equipment Held for Sale

In accordance with guidance provided by the FASB, flight equipment is classified as held for sale when we commit to and commence a plan of sale that is reasonably expected to be completed within one year and satisfies certain other held for sale criteria. Flight equipment held for sale is recorded as the lesser of carrying value or fair value, less estimated cost to sell. An impairment loss is recorded for an asset held for sale when the carrying value of the asset exceeds its fair value, less estimated cost to sell. An aircraft classified as held for sale will not depreciate.

Subsequent changes to the asset’s fair value are recorded as adjustments to the carrying value of the flight equipment. However, any such adjustment will not exceed the original carrying value of the flight equipment held for sale. As of June 30, 2015, we had 33 aircraft held for sale with a total net book value of $933.7 million. There was no flight equipment held for sale as of December 31, 2014.

New Accounting Pronouncements

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) . ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenues arising from contracts with customers. The guidance specifically notes that lease contracts with customers are a scope exception. ASU 2014-09 is effective for annual reporting periods (including interim periods), beginning after December 15, 2016, and early adoption is not permitted. We will adopt the guidance effective January 1, 2017. We anticipate that the adoption of the standard will not have a material effect on our consolidated financial condition, result of operations or cash flows.

In August 2014, FASB issued ASU 2014-15, update to Accounting Standards Codification (ASC) subtopic 250-40, Presentation of Financial Statements-Going Concern . The amendments require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in the U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term “substantial doubt”, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). ASU 2014-15 is effective for annual reporting periods (including interim periods) ending after December 15, 2016, and early adoption is permitted. We will adopt the guidance effective January 1, 2017.

In February 2015, FASB issued ASU 2015-02, which amends ASC 810 , Consolidation . The amendment significantly changes the consolidation analysis required under U.S. GAAP and could have a significant impact on the consolidation conclusions of the reporting entity. ASU 2015-02 is effective for annual reporting periods (including interim periods), beginning after December 15, 2015. Early adoption is permitted. We will adopt the guidance effective January 1, 2016. We are currently assessing the impact on our consolidated financial statements and notes to our consolidated financial statements.

In April 2015, FASB issued ASU 2015-03, Interest - Imputation of Interest , which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with the accounting treatment for debt discounts. The recognition and measurement guidance of debt issuance costs are not affected by this update. The guidance, which requires retrospective application, will be adopted by us effective January 1, 2016.

Operating Results

Management’s discussion and analysis of operating results presented below pertain to the consolidated statements of income of Fly for the three month periods ended June 30, 2015 and 2014.

Consolidated Statements of Income of Fly for the three month periods ended June 30, 2015 and 2014