<PAGE>   1

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                      ------------------------------------

                                   FORM 10-Q

[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
      EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MAY 31, 1999

                                       OR

[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
      EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM             TO

                        COMMISSION FILE NUMBER 333-56575
                      ------------------------------------

                        MORGAN STANLEY AIRCRAFT FINANCE
            Exact Name of Registrant as specified in trust agreement

<TABLE>
<S>                                            <C>
                   DELAWARE                                      13-3521640
         (State or other jurisdiction                         I.R.S. Employer
      of incorporation or organization)                    Identification Number
</TABLE>

                          C/O WILMINGTON TRUST COMPANY
                           1100 NORTH MARKET STREET,
                              RODNEY SQUARE NORTH
                              WILMINGTON, DELAWARE
                                   19890-0001
                                 (302-651-1000)
             (Address and telephone number, including area code, of
                    Registrant's principal executive office)

                      ------------------------------------

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                      Yes  [X]                    No  [ ]
                      ------------------------------------

                     APPLICABLE ONLY TO CORPORATE ISSUERS:

     Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
                                                                                     OUTSTANDING AT
ISSUER                                                              CLASS            JUNE 30, 1999
-------------------------------------------------------------------------------------------------------
<S>                                                          <C>                 <C>
Morgan Stanley Aircraft Finance............................  Beneficial Interest          One
-------------------------------------------------------------------------------------------------------
</TABLE>

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>   2

                        MORGAN STANLEY AIRCRAFT FINANCE

                  FORM 10-Q FOR THE QUARTER ENDED MAY 31, 1999

                                     INDEX

<TABLE>
<CAPTION>
                                                              PAGE NO.
                                                              --------
<S>                                                           <C>
PART I. FINANCIAL INFORMATION...............................      2
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)....................      2
  -- Interim Condensed Consolidated Financial Statements
     (Unaudited)............................................      2
  -- Notes to the Interim Condensed Consolidated Financial
     Statements (Unaudited).................................      6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
        CONDITION AND RESULTS OF OPERATIONS.................     13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
        MARKET RISK.........................................     24
PART II. OTHER INFORMATION..................................     26
ITEM 1. NOT APPLICABLE
ITEM 2. NOT APPLICABLE
ITEM 3. NOT APPLICABLE
ITEM 4. NOT APPLICABLE
ITEM 5. NOT APPLICABLE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................     26
SIGNATURES..................................................     27
INDEX TO EXHIBITS...........................................     28
APPENDIX 1..................................................     29
</TABLE>

                                        1
<PAGE>   3

                         PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

                 INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                  MAY 31,       NOV 30,
                                                                   1999           1998
                                                                -----------    ----------
                                                                (UNAUDITED)
<S>                                                             <C>            <C>
                           ASSETS
Cash and cash equivalents...................................    $   37,415     $   34,850
Receivables:
  Lease income, net.........................................         3,174          3,744
  Investment income and other...............................           143            153
Aircraft under operating leases, net........................       909,581        933,111
Investment in capital lease, net............................        19,059         21,581
Underwriting and other issuance related costs, net of
  amortization..............................................        16,494         17,053
                                                                ----------     ----------
Total Assets................................................    $  985,866     $1,010,492
                                                                ==========     ==========
            LIABILITIES AND BENEFICIAL INTERESTHOLDER'S DEFICIT
Payables:
  Interest payable to Noteholders...........................    $    2,441     $    2,655
Deferred rental income......................................         5,281          7,351
Liability for maintenance...................................        55,647         52,489
Other liabilities...........................................        13,448         15,865
Notes payable:
  Subclass A-1..............................................       400,000        400,000
  Subclass A-2..............................................       256,056        274,062
  Subclass B-1..............................................        92,942         94,819
  Subclass C-1..............................................       100,000        100,000
  Subclass D-1..............................................       110,000        110,000
                                                                ----------     ----------
                                                                 1,035,815      1,057,241
                                                                ----------     ----------
Commitments and contingencies
Beneficial Interestholder's Deficit:
  Beneficial Interest.......................................             1              1
  Deemed Distribution.......................................       (15,305)       (15,305)
  Accumulated Deficit.......................................       (34,645)       (31,445)
                                                                ----------     ----------
  Total Beneficial Interestholder's Deficit.................       (49,949)       (46,749)
                                                                ----------     ----------
Total Liabilities and Beneficial Interestholder's Deficit...    $  985,866     $1,010,492
                                                                ==========     ==========
</TABLE>

     See Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)

                                        2
<PAGE>   4

                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

            INTERIM CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                   THREE MONTHS ENDED       SIX MONTHS ENDED
                                                        MAY 31,                 MAY 31,
                                                  --------------------    --------------------
                                                    1999        1998        1999        1998
                                                  --------    --------    --------    --------
                                                                  (UNAUDITED)
<S>                                               <C>         <C>         <C>         <C>
Revenues:
  Lease income, net...........................    $ 32,045    $ 32,688    $ 59,133    $ 57,805
  Investment income on collection account.....         450         961         881         961
                                                  --------    --------    --------    --------
  Total revenues..............................      32,495      33,649      60,014      58,766
                                                  --------    --------    --------    --------
Expenses:
  Interest expense............................      16,046      16,664      32,395      16,664
  Depreciation expense........................      11,765      11,523      23,530      15,346
  Operating expenses:
     Service provider and other fees..........       2,244       2,839       4,291       5,676
     Maintenance and other aircraft related
       costs..................................       1,926       1,921       2,998       2,296
                                                  --------    --------    --------    --------
  Total expenses..............................      31,981      32,947      63,214      39,982
                                                  --------    --------    --------    --------
Net income/(loss).............................    $    514    $    702    $ (3,200)   $ 18,784
                                                  ========    ========    ========    ========
</TABLE>

     See Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)

                                        3
<PAGE>   5

                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
            INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                              SIX MONTHS ENDED    SIX MONTHS ENDED
                                                                MAY 31, 1999        MAY 31, 1998
                                                              ----------------    ----------------
                                                                          (UNAUDITED)
<S>                                                           <C>                 <C>
Cash flows from operating activities
  Net (loss)/income.......................................       $  (3,200)          $  18,784
  Adjustments to reconcile net (loss)/income to net cash
     provided by operating activities:
  Depreciation expense -- aircraft under operating
     leases...............................................          23,530              15,346
  Amortization of underwriting and other issuance related
     costs................................................             559                 279
  Provision for doubtful accounts.........................           6,021                  --
  Changes in assets and liabilities:
     Receivables:
       Investment income and other........................              10                (189)
       Lease income.......................................          (2,564)               (609)
     Investment in capital lease..........................            (365)              3,505
     Liability for maintenance............................           3,158               7,148
     Interest payable to Noteholders......................            (214)              2,753
     Deferred rental income...............................          (2,070)              7,495
     Other liabilities....................................          (2,417)              1,267
                                                                 ---------           ---------
Net cash provided by operating activities.................          22,448              55,779
                                                                 ---------           ---------
Cash flows from investing activities
  Purchase of aircraft....................................              --            (887,315)
                                                                 ---------           ---------
Net cash used for investing activities....................              --            (887,315)
                                                                 ---------           ---------
Cash flows from financing activities
  Proceeds from Notes, net of issuance costs..............              --           1,041,610
  Proceeds from borrowings from Morgan Stanley Financing
     Inc..................................................              --             853,490
  Repayment of borrowings from Morgan Stanley Financing
     Inc., including beneficial interest distribution.....              --            (976,257)
  Repayments of Notes.....................................         (19,883)            (14,982)
  Other costs incurred relating to the issuance of
     notes................................................              --              (9,500)
                                                                 ---------           ---------
Net cash (used for) provided by financing activities......         (19,883)            894,361
                                                                 ---------           ---------
Net increase in cash and cash equivalents.................           2,565              62,825
Cash and cash equivalents at beginning of period..........          34,850                  --
                                                                 ---------           ---------
Cash and cash equivalents at end of period................       $  37,415           $  62,825
                                                                 =========           =========
</TABLE>

     See Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)

                                        4
<PAGE>   6

                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

       INTERIM CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN BENEFICIAL
                               INTEREST/(DEFICIT)
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                           RETAINED            TOTAL
                                                                           EARNINGS         BENEFICIAL
                                             BENEFICIAL      DEEMED      (ACCUMULATED        INTEREST
                                              INTEREST    DISTRIBUTION     DEFICIT)          (DEFICIT)
                                             ----------   ------------   ------------   -------------------
                                                                      (UNAUDITED)
<S>                                          <C>          <C>            <C>            <C>
Balance at November 30, 1997..............    $      1      $     --       $  4,704          $  4,705
Net income................................          --            --         18,784            18,784
Deemed Distribution.......................          --       (15,305)            --           (15,305)
Borrowings from Morgan Stanley Financing
  Inc. converted into Beneficial
  Interest................................     919,859            --             --           919,859
Payment of Beneficial Interest
  Distribution to Morgan Stanley Financing
  Inc.....................................    (919,859)           --        (56,398)         (976,257)
                                              --------      --------       --------          --------
Balance at May 31, 1998...................    $      1      $(15,305)      $(32,910)         $(48,214)
                                              ========      ========       ========          ========
</TABLE>

<TABLE>
<CAPTION>
                                                                            RETAINED            TOTAL
                                                                            EARNINGS         BENEFICIAL
                                              BENEFICIAL      DEEMED      (ACCUMULATED        INTEREST
                                               INTEREST    DISTRIBUTION     DEFICIT)          (DEFICIT)
                                              ----------   ------------   ------------   -------------------
                                                                       (UNAUDITED)
<S>                                           <C>          <C>            <C>            <C>
Balance at November 30, 1998...............    $      1      $(15,305)      $(31,445)         $(46,749)
Net loss...................................          --            --         (3,200)           (3,200)
                                               --------      --------       --------          --------
Balance at May 31, 1999....................    $      1      $(15,305)      $(34,645)         $(49,949)
                                               ========      ========       ========          ========
</TABLE>

     See Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)

                                        5
<PAGE>   7

                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

  NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1 -- BASIS OF PRESENTATION

     Morgan Stanley Aircraft Finance ("MSAF") is a special purpose business
trust that was formed on October 30, 1997 under the laws of Delaware. MSAF and
its subsidiaries ("MSAF Group") were formed to conduct certain limited
activities, including acquiring, financing, re-financing, owning, leasing,
re-leasing, selling, maintaining and modifying commercial aircraft. All of the
beneficial interest of MSAF Group is owned by Morgan Stanley Financing, Inc.
("MSF"), a wholly-owned subsidiary of Morgan Stanley Dean Witter & Co. ("MSDW").
MSAF Group's obligations, including its financial debt obligations, are not
obligations of, or guaranteed by, MSDW, MSF or any person other than MSAF Group.

     The interim condensed consolidated financial statements are prepared in
accordance with generally accepted accounting principles, which require
management to make estimates and assumptions that affect the financial
statements and related disclosures. Management believes that the estimates
utilized in the preparation of the interim condensed consolidated financial
statements are prudent and reasonable. Actual results could differ materially
from these estimates.

     All material intercompany transactions have been eliminated.

     The interim condensed consolidated financial statements should be read in
conjunction with MSAF Group's consolidated financial statements and notes
thereto as of and for the twelve months ended November 30, 1998 ("Fiscal 1998").
The interim condensed consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) which are, in the opinion of
management, necessary for the fair statement of the results for the interim
period. The results of operations for interim periods are not necessarily
indicative of results for the entire year.

     Certain reclassifications have been made to prior year amounts to conform
to the current presentation.

     New Accounting Pronouncement

     In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"), which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. As issued,
SFAS No. 133 was effective for fiscal years beginning after June 15, 1999. In
June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments
and Hedging Activities -- Deferral of the Effective Date of FASB Statement No.
133". SFAS No. 137 deferred the effective date of SFAS No. 133 for one year to
fiscal years beginning after June 15, 2000. MSAF Group is in the process of
evaluating the impact of adopting SFAS No. 133.

NOTE 2 -- CONCENTRATIONS OF CREDIT RISK

     Credit risk with respect to operating lease receivables is generally
diversified due to the number of lessees comprising MSAF Group's customer base
and the different geographic areas in which they operate. At May 31, 1999 MSAF
Group had leased aircraft to 29 lessees in 19 countries.

     Many of MSAF Group's lessees are in a relatively weak financial position
because of the difficult economic conditions in the civil aviation industry as a
whole and because, in general, weakly capitalized airlines are more likely to
seek operating leases. In addition, at May 31, 1999, 11 of MSAF Group's aircraft
are being leased to lessees domiciled in certain emerging market nations,
including those located in Eastern Europe, the Middle East, Latin America and
Asia. Emerging market economies have been affected by severe economic and
financial difficulties. The exposure of MSAF Group's aircraft to particular
countries and customers is managed partly through concentration limits and
through obtaining security from lessees by way

                                        6
<PAGE>   8
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) --
                                  (CONTINUED)

of deposits. MSAF Group will continue to manage its exposure to particular
countries, regions and lessees through concentration limits.

NOTE 3 -- AIRCRAFT

<TABLE>
<CAPTION>
                                                                MAY 31, 1999    NOV 30, 1998
                                                                ------------    ------------
                                                                   (DOLLARS IN THOUSANDS)
<S>                                                             <C>             <C>
Stage 3 Aircraft and one spare engine:
Cost........................................................      $972,030        $972,030
Less: Accumulated depreciation..............................       (62,449)        (38,919)
                                                                  --------        --------
                                                                  $909,581        $933,111
                                                                  ========        ========
Aircraft cost includes $38.7 million of maintenance
  liabilities that MSAF Group assumed at the date of
  purchase.
Fleet Analysis:
On lease for a further period of:
More than five years........................................             7               7
From one to five years......................................            23              20
Less than one year..........................................             2               5
                                                                  --------        --------
Total aircraft portfolio (including one spare engine and
  excluding aircraft under capital lease)...................            32              32
                                                                  ========        ========
</TABLE>

     At May 31, 1999, there was one non-revenue earning aircraft in MSAF Group's
portfolio which was subject to a signed lease agreement commencing in June 1999.

NOTE 4 -- INVESTMENT IN CAPITAL LEASE

     One of MSAF Group's aircraft has been leased to a customer under a
sales-type capital lease. The components of MSAF Group's investment in this
lease are as follows:

<TABLE>
<CAPTION>
                                                                MAY 31, 1999    NOV 30, 1998
                                                                ------------    ------------
                                                                   (DOLLARS IN THOUSANDS)
<S>                                                             <C>             <C>
Minimum lease payments receivable...........................      $ 26,285        $ 26,662
Less: Allowance for doubtful accounts.......................        (3,023)           (136)
                                                                  --------        --------
Net minimum lease payments receivable.......................        23,262          26,526
Less: Unearned income.......................................        (4,203)         (4,945)
                                                                  --------        --------
Net investment in capital lease.............................      $ 19,059        $ 21,581
                                                                  ========        ========
</TABLE>

     At May 31, 1999, minimum lease payments for each of the five succeeding
fiscal years are $4 million.

     Unearned income is recognized over the term of the lease using the interest
method.

     The change in the allowance for doubtful accounts of $2.9 million for the
six months ended May 31, 1999 is recorded as a reduction of lease income
revenues in the Interim Condensed Consolidated Statements of Operations.

                                        7
<PAGE>   9
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) --
                                  (CONTINUED)

NOTE 5 -- LEASE INCOME RECEIVABLE

     Lease income receivable was as follows:

<TABLE>
<CAPTION>
                                                                MAY 31, 1999    NOV 30, 1998
                                                                ------------    -------------
                                                                   (DOLLARS IN THOUSANDS)
<S>                                                             <C>             <C>
Lease income receivable.....................................      $  6,861        $  4,297
Less: Allowance for doubtful accounts.......................        (3,687)           (553)
                                                                  --------        --------
Lease income receivable, net................................      $  3,174        $  3,744
                                                                  ========        ========
</TABLE>

     The change in the allowance for doubtful accounts of $3.1 million for the
six months ended May 31, 1999 is recorded as a reduction of lease income
revenues in the Interim Condensed Consolidated Statements of Operations.

NOTE 6 -- LIABILITY FOR MAINTENANCE

     Activity in the liability for maintenance account was as follows:

<TABLE>
<CAPTION>
                                                                MAY 31, 1999    NOV 30, 1998
                                                                ------------    ------------
                                                                   (DOLLARS IN THOUSANDS)
<S>                                                             <C>             <C>
Balance, beginning of period................................      $ 52,489        $     --
Liabilities assumed from International Lease Finance
  Corporation...............................................            --          38,735
Collections from lessees....................................         8,438          15,837
Reimbursements to lessees...................................        (4,991)         (2,633)
Net accruals and transfers..................................          (289)            550
                                                                  --------        --------
Balance, end of period......................................      $ 55,647        $ 52,489
                                                                  ========        ========
</TABLE>

NOTE 7 -- NOTES PAYABLE

     MSAF Group has acquired 32 aircraft and one spare engine having an
aggregate cost of $972 million. MSAF Group financed these purchases primarily
through borrowings from MSF and from the net proceeds from MSAF Group's private
placement of securitized notes as discussed below.

     On March 3, 1998, MSAF Group completed an offering of $1,050 million of
securitized notes (the "Notes") on a basis exempt from registration under the
Securities Act of 1933, as amended. Simultaneous with the private placement, the
loan provided by MSF was automatically converted into a beneficial interest held
by MSF. MSAF Group primarily utilized the proceeds from the Notes to pay a
beneficial interest distribution to MSF and to acquire an additional aircraft.
With the exception of MSAF Group, the Notes are not obligations of, or
guaranteed by, MSDW or any of its subsidiaries, including MSF.

     Underwriting and other issuance related costs of $17.9 million which were
incurred in connection with the offering are being amortized over the expected
life of the Notes, which is currently estimated to be 16 years.

                                        8
<PAGE>   10
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) --
                                  (CONTINUED)

     The repayment terms of each subclass of Notes are such that certain
principal amounts are expected to be repaid based on certain assumptions (the
"Expected Final Payment Date") or refinanced through the issuance of new Notes,
but in any event are ultimately due for repayment on specified final maturity
dates (the "Final Maturity Date"). The Expected Final Payment Dates, Final
Maturity Dates and interest rates applicable to each subclass of the Notes are
listed below:

<TABLE>
<CAPTION>
                                INITIAL
                               PRINCIPAL
                                 AMOUNT                         EXPECTED FINAL    FINAL MATURITY
SUBCLASS OF NOTE             (IN THOUSANDS)    INTEREST RATE     PAYMENT DATE          DATE
----------------             --------------    -------------    --------------    --------------
<S>                          <C>               <C>              <C>               <C>
Subclass A-1.............       400,000         LIBOR+0.21%     March 15, 2000    March 15, 2023
Subclass A-2.............       340,000         LIBOR+0.35%     Sept. 15, 2005    March 15, 2023
Subclass B-1.............       100,000         LIBOR+0.65%     March 15, 2013    March 15, 2023
Subclass C-1.............       100,000               6.90%     March 15, 2013    March 15, 2023
Subclass D-1.............       110,000               8.70%     March 15, 2014    March 15, 2023
</TABLE>

     If the Subclass A-1 Notes are not repaid on or before the Expected Final
Payment Date for such subclass, such subclass of Notes will accrue interest
thereafter at a rate equal to the stated interest rate therefor, plus 0.50% per
annum ("Step-Up Interest").

     MSAF Group filed a registration statement with the Securities and Exchange
Commission (the "SEC") with respect to an exchange offer (the "Exchange Offer")
for exchange Notes with terms identical to the Notes which was declared
effective on January 12, 1999. The Exchange Offer was consummated on January 18,
1999. MSAF Group paid an additional coupon of 0.50% on each of the subclasses of
debt during the period from November 30, 1998 to January 18, 1999, as required
under the terms of the Notes.

     The dates on which principal repayments on the Notes will actually occur
will depend on the cash flows generated by the rental income from MSAF Group's
portfolio of aircraft. Amounts received by MSAF Group are available for
distribution and are paid in accordance with the priorities specified in the
indenture relating to the Notes.

     Cash paid for interest on the Notes amounted to $29.7 million for the six
month period ended May 31, 1999, as compared to $13.4 million for the six month
period ended May 31, 1998. The interest expense for Fiscal 1999 is not
comparable to Fiscal 1998 as the Notes were not issued until March 3, 1998.

NOTE 8 -- LIQUIDITY FACILITIES

     MSAF Group requires liquidity in order to finance many of its primary
business activities, including maintenance obligations, security deposit return
obligations, operating expenses and obligations under the Notes. MSAF Group's
primary sources of liquidity are cash bank deposits and letters of credit.

     The Company's cash account (the "Collection Account") is primarily funded
through the receipt of rental payments from lessees.

     In connection with the issuance of the Notes, the Company entered into two
credit agreements. Under a Custody and Loan Agreement (the "ILFC Facility")
between International Lease Finance Corporation ("ILFC") and MSAF Group, ILFC
will hold substantially all of the cash security deposits paid by lessees with
respect to MSAF Group's aircraft portfolio and will retain the interest earnings
on such security deposits. In addition, ILFC has agreed to extend loans to MSAF
Group in a maximum amount of $10 million plus the aggregate amount of cash
security deposits held by ILFC. Under a Loan Agreement (the "MSDW Facility")
between MSDW and MSAF Group, MSDW has agreed to extend loans in a maximum amount
of $10 million.
                                        9
<PAGE>   11
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) --
                                  (CONTINUED)

     As of May 31, 1999, the aggregate amount available under the ILFC Facility
and the MSDW Facility was approximately $41.1 million.

NOTE 9 -- DERIVATIVE FINANCIAL INSTRUMENTS

     The leasing revenues of MSAF Group are generated primarily from rental
payments. Rental payments are currently entirely fixed but may be either fixed
or floating with respect to leases entered into in the future. In general, an
interest rate exposure arises to the extent that MSAF Group's fixed and floating
interest obligations in respect of the Notes do not correlate to the mix of
fixed and floating rental payments for different rental periods. This interest
rate exposure can be managed through the use of interest rate swaps and other
derivative instruments. The Subclass A-1, A-2 and B-1 Notes bear floating rates
of interest and the Subclass C-1 and D-1 Notes bear fixed rates of interest.
MSAF Group is a party to eight interest rate swaps with Morgan Stanley Capital
Services Inc. ("MSCS"), a wholly-owned subsidiary of MSDW. In six of these
swaps, MSAF Group pays a fixed monthly coupon and receives one month LIBOR on a
notional balance of $1,000 million and in two of these swaps, MSAF Group pays
one month LIBOR and receives a fixed monthly coupon on a notional balance of
$200 million.

     All eight swaps were originally entered into by MSCS, with an internal
swaps desk as the counterparty, on November 12, 1997 and February 19, 1998,
respectively. On March 3, 1998, all eight swaps were assigned to MSAF Group by
MSCS. Although MSAF Group's floating rate liability at March 3, 1998 was $800
million (after the repayment of principal due to an undelivered aircraft), the
net economic effect of assigning all eight swaps to MSAF Group with an aggregate
notional amount of $1.2 billion was to fix the interest rate liability at the
November 12, 1997 interest rate. MSAF Group required this certainty both in
furtherance of its interest rate management policy not to be adversely exposed
to material movements in interest rates from November 12, 1997 (shortly after
MSAF entered into the Asset Purchase Agreement) and by fixing the principal
liabilities relating to the transaction, to facilitate the structuring of the
transaction.

     On the date that the eight interest rate swaps were assigned from MSCS to
MSAF Group, such swaps had an aggregate fair value of approximately $(15.3)
million. No consideration was paid to or received by MSAF Group in connection
with the assumption of these swap positions. MSAF Group has recorded the
assumption of these interest rate swaps at their fair value by recognizing a
liability within Other liabilities in its Condensed Consolidated Balance Sheets,
with a corresponding charge to Deemed Distribution, a component of Beneficial
Interestholder's Deficit.

     Four of the swaps assumed from MSCS having an aggregate notional principal
amount of $800 million are accounted for as hedges of its obligations under the
Notes. Under these swap arrangements MSAF Group will pay fixed and receive
floating amounts on a monthly basis. The fair value of the liability assumed
relating to those swaps which are being accounted for as hedges is being
deferred and recognized when the offsetting gain or loss is recognized on the
hedged transaction. This amount and the differential payable or receivable on
such interest rate swap contracts, to the extent such swaps are deemed to be
effective hedges, is recognized as an adjustment to interest expense. The
portion of these swaps not deemed to be an effective hedge is accounted for on a
mark-to-market basis with changes in fair value reflected in interest expense.
Gains and losses resulting from the termination of such interest rate swap
contracts prior to their stated maturity are deferred and recognized when the
offsetting gain or loss is recognized on the hedged transaction. The fair value
of these interest rate swaps at May 31, 1999 was $(4.5) million.

     The remaining four swaps assumed by MSAF Group have an aggregate gross
notional principal amount of $400 million. Under these swap arrangements, MSAF
Group will pay/receive fixed and receive/pay floating amounts on a monthly
basis. MSAF Group determined that these swaps do not qualify for hedge
accounting. The fair value of the liability assumed related to these swaps is
accounted for on a mark-to-market
                                       10
<PAGE>   12
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) --
                                  (CONTINUED)

basis with changes in fair value reflected in interest expense. At May 31, 1999,
the fair value of these swaps was $(7.0) million.

     The gross notional amounts of these swaps are indicative of MSAF Group's
degree of use of such swaps but do not represent MSAF Group's exposure to credit
or market risk. Credit risk arises from the failure of the counterparty to
perform according to the terms of the swap contract. MSAF Group's exposure to
credit risk at any point in time is represented by the fair value of the swap
contracts reported as assets. MSAF Group does not currently require collateral
to support swap contracts with credit risk. The credit risk of these swap
contracts is monitored by MSAF Group's Trustees.

     MSAF Group does not utilize derivative financial instruments for trading
purposes.

NOTE 10 -- RELATED PARTY TRANSACTIONS

     Under service agreements with MSAF Group, Cabot Aircraft Services Limited
and Morgan Stanley & Co. Incorporated, both subsidiaries of MSDW, act as
Administrative Agent and Financial Advisor, respectively. During the six month
period ended May 31, 1999, Cabot Aircraft Services Limited received a fee of
$0.8 million for providing these services, which is calculated as a percentage
of the operating lease rentals received. Morgan Stanley & Co. Incorporated
received advisory fees of $0.02 million in this period.

     Prior to the issuance of the Notes, MSAF Group received approximately $920
million of non-interest bearing financing from MSF which was utilized to
purchase 31 of the 32 aircraft and a spare engine in its aircraft portfolio. At
the time of the issuance of the Notes, this loan was automatically converted
into a beneficial interest and a payment of approximately $976 million was made
in the form of a distribution on such beneficial interest and comprised the
following amounts (dollars in millions):

<TABLE>
<S>                                                           <C>
Non-interest bearing loans (subsequently converted into
  beneficial interest)......................................  $920
Distribution (comprising $21 million in lease rentals
  accrued to the date of issuance of the Notes with the
  balance representing finance and other charges paid to
  MSF)......................................................    56
                                                              ----
Total Beneficial Interest Distribution......................  $976
                                                              ====
</TABLE>

     In connection with the issuance of the Notes, MSAF Group paid approximately
$7.1 million in subscription discounts and commissions to subsidiaries of MSDW.

     MSAF Group's counterparty to its interest rate swap agreements is MSCS, a
wholly-owned subsidiary of MSDW.

     MSAF Group's management is comprised of six trustees, including the
Delaware trustee, as MSAF Group has no employees or executive officers. Three of
MSAF Group's six trustees and one alternate trustee are employees of MSDW. MSAF
Group's remaining two trustees are unaffiliated with MSDW.

NOTE 11 -- COMMITMENTS

     MSAF Group did not have any material contractual commitments for capital
expenditures at May 31, 1999.

     In accordance with the terms of a servicing agreement (the "Servicing
Agreement"), ILFC (the "Servicer") is performing certain aircraft related
activities with respect to MSAF Group's aircraft portfolio. Such activities
include marketing MSAF Group's aircraft for lease or sale and monitoring lessee
compliance with lease terms including terms relating to payment, maintenance and
insurance. In accordance with the

                                       11
<PAGE>   13
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES

NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) --
                                  (CONTINUED)

Servicing Agreement, fees payable to ILFC by MSAF Group are calculated as a
percentage of the lease rentals received, in addition to a base fee and certain
incentive-based fees.

     The Servicing Agreement expires in 2023, although each party has the right
to terminate the Servicing Agreement under certain circumstances.

                                       12
<PAGE>   14

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

INTRODUCTION

     The MSAF Group entities were organized in late 1997 and since that time
their principal business activity has been the acquisition of aircraft and the
placement of such aircraft on operating lease. MSAF Group's future business is
expected to consist principally of aircraft operating lease activities,
acquisitions of additional aircraft and sales of aircraft. Currently, MSAF Group
is in negotiations to acquire an additional portfolio of aircraft. Cash flows
generated from such activities will be used to service interest and principal on
the Notes, any refinancing notes and any additional notes but only after various
expenses of MSAF Group have been paid for, including any taxes, obligations to
lessees including maintenance obligations, fees and expenses of ILFC and other
service providers and payments to MSAF Group's interest rate swap
counterparties.

     MSAF Group's ability to generate sufficient cash from its aircraft assets
to service the Notes will depend primarily on (i) the rental rates it can
achieve on leases and the lessees' ability to perform according to the terms of
those leases and (ii) the prices it can achieve on any aircraft sales. MSAF
Group's ability to service the Notes will also depend on the level of its
operating expenses, including maintenance obligations which will increase as the
aircraft age, and on any unforeseen contingent liabilities arising.

     MSAF Group's cash receipts and disbursements are determined, in part, by
the overall economic condition of the operating leasing market. The operating
leasing market, in turn, is affected by various cyclical factors including
interest rates, the availability of credit, fuel costs and general and regional
economic conditions affecting lessee operations and trading; manufacturer
production levels; passenger demand; retirement and obsolescence of aircraft
models; manufacturers exiting or entering the market or ceasing to produce
aircraft types; re-introduction into service of aircraft previously in storage;
governmental regulation; and air traffic control infrastructure constraints such
as limitations on the number of landing slots.

     MSAF Group's ability to compete against other lessors is determined, in
part, by (i) the composition of its fleet in terms of mix, relative age and
popularity of the aircraft types; (ii) operating restrictions imposed by the
Indenture, and (iii) the ability of other lessors, who may possess substantially
greater financial resources, to offer leases on more favorable terms than MSAF
Group.

     Any statements contained herein that are not historical facts, or that
might be considered an opinion or projection, whether expressed or implied, are
meant as, and should be considered, forward-looking statements as that term is
defined in the Private Securities Litigation Reform Act of 1995. Forward-looking
statements are based on assumptions and opinions concerning a variety of known
and unknown risks. If any assumptions or opinions prove incorrect, any
forward-looking statements made on that basis may also prove materially
incorrect.

RECENT DEVELOPMENTS

     THE AIRCRAFT

     As of May 31, 1999, the total number of aircraft owned by MSAF Group was 32
aircraft plus a spare engine.

     LESSEE DIFFICULTIES

     As of July 1, 1999, three current lessees were in arrears. The aircraft on
lease to the three lessees in arrears represent approximately 11.1% of the
appraised value of the portfolio at September 30, 1998 and all three lessees are
based in Brazil. The amounts outstanding and overdue for the three lessees in
respect of rental payments, maintenance reserves and other miscellaneous amounts
due under the leases (net of default interest and certain cash in transit)
amounted to approximately $8.6 million. The weighted average number of days past
due of such arrears was 105 days. See "Latin America" below.

     In addition, as of July 1, 1999, an aggregate of $2.2 million was owed to
MSAF Group from two of its former lessees. In both cases, MSAF Group has leased
the aircraft to other lessees.
                                       13
<PAGE>   15

     EUROPE & MIDDLE EAST EMERGING

     Following the termination of a lease with Onur Air, the related aircraft
(an A321-100) was placed with another Turkish charter airline, Air Alfa. Rental
payments and maintenance reserves outstanding under the old lease amounted to
approximately $2.0 million. However, Onur Air has commenced payment of
restructured amounts in accordance with a termination agreement. Amounts in
arrears are scheduled for repayment by October 1999. The aircraft represents
4.3% of the appraised value of the portfolio at September 30, 1998.

     ASIA

     Asia has been severely affected by economic and financial difficulties,
although limited signs of recovery were exhibited during the quarter. Currently,
MSAF Group leases 13.0% of its fleet in the Asia Region (5.5% in South Korea,
4.9% in Taiwan and 2.6% in China) and 6.7% in Pacific and Other regions (6.7% in
Fiji) by appraised value of the portfolio at September 30, 1998. As of July 1,
1999 none of these lessees were in arrears although severe financial
difficulties have been reported for certain other air carriers in the region.
One lessee restructured its lease such that rental payments will be lower over
an extended lease term.

     LATIN AMERICA

     Considerable economic uncertainty continues to affect the major economies
in Latin America. The devaluation of the Brazilian currency in January 1999
continued to adversely impact the major carriers whose lease obligations were
predominantly in U.S. dollars.

     As of July 1, 1999, VARIG had decided to terminate the lease of a B747-300
aircraft, and is currently negotiating a termination agreement with ILFC.
However, due to the generally difficult state of the leasing market for this
type of aircraft, there can be no assurance that ILFC will be able to procure a
new lease with terms similar to those of the terminated lease with VARIG. As of
July 1, 1999, the total amount outstanding for this lessee in respect of rental
payments and maintenance reserves amounted to approximately $4.8 million. The
aircraft represents 6.1% of the appraised value of the portfolio at September
30, 1998.

     Another Brazilian lessee, Passaredo, representing 2.1% of the appraised
value of the portfolio at September 30, 1998, has been operating one A310-300
subject to a finance lease and has not made lease payments since September 1998.
After protracted negotiations with ILFC, the lessee has agreed to a repayment
schedule, which provides for payment of part of the arrears. As of July 1, 1999,
the total amount outstanding for this lessee in respect of rental payments
amounted to approximately $3.3 million.

     The rental arrears of the third Brazilian lessee, which accounts for 2.9%
of the appraised value of the portfolio at September 30, 1998 have been
restructured, and the lessee is in arrears with respect to the restructured
amounts.

     MSAF Group currently leases 17.4% of its fleet in Latin America (6.3% in
Mexico and 11.1% in Brazil) by appraised value of the portfolio at September 30,
1998.

     OTHER

     The lease with Guyana Airways was terminated by agreement on April 2, 1999
with rental arrears of $1.3 million. The total estimated costs of redelivery are
likely to be in excess of amounts to be received from Guyana Airways. The
aircraft is a B757-200 and accounts for 3.3% of the appraised value of the
portfolio at September 30, 1998. The aircraft was re-leased to National
Airlines, a U.S. carrier in June 1999.

     NEW AIRCRAFT SAFETY STANDARD

     The U.S. Federal Aviation Administration (the "FAA") has indicated that it
will develop in the near term a new test specification for insulation for the
purpose of increasing fire safety on aircraft. The FAA has also begun discussion
with the international aviation authorities on this matter. In addition, the FAA
has indicated that it will propose requiring the use of improved insulation once
the new test standard is developed.
                                       14
<PAGE>   16

It is possible that additional service bulletins, new maintenance practices and
mandatory airworthiness directives may be issued while the new standard for
insulation is developed. If new standards for insulation are implemented, MSAF
Group could incur significant costs in ensuring its aircraft comply with these
standards which could impact adversely on MSAF Group's results of operations. It
is currently not clear whether or to what extent manufacturers, owners or
lessees would be responsible for the costs necessary to bring aircraft in
compliance with such new test standards.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MAY 31, 1999,
AND THE THREE MONTHS ENDED MAY 31, 1998

     NET INCOME

     Net income for the three month period ended May 31, 1999 amounted to $0.5
million, as compared to net income of $0.7 million for the three month period
ended May 31, 1998. The decrease reflects lower rental revenues, partially
offset by a decline in interest and operating expenses.

     MSAF Group is a Delaware business trust treated as a branch of MSF for U.S.
federal, state and local income tax purposes. As such, MSAF Group is not subject
to U.S. federal, state and local income taxes.

     LEASE INCOME

     Lease income for the three month period ended May 31, 1999 amounted to
$32.0 million as compared to $32.7 million for the three month period May 31,
1998. MSAF Group's operating results for the three month period ended May 31,
1999 were adversely affected by provisions for doubtful accounts totaling $3.0
million. Such provisions were recorded by MSAF Group due to financial
difficulties experienced by certain of MSAF Group's current lessees, as well as
to reserve against amounts owed to MSAF Group by certain of its former lessees
whose aircraft have already been repossessed (see "LESSEE DIFFICULTIES"). No
provisions for doubtful accounts were recorded in the three month period ended
May 31, 1998. Lease income may decline during the remainder of Fiscal 1999 due
to potential lessee defaults and arrears, particularly given the difficult
operating conditions for Latin American lessees as discussed above.

     MSAF Group records the cash prepayments made by lessees for maintenance as
a component of the liability for maintenance account which appears on the
Interim Condensed Consolidated Balance Sheets. When the lessee incurs
maintenance expenditures, MSAF Group must return a corresponding amount of the
prepayment to the lessee. At this time, MSAF Group will forward cash to the
lessee, with a corresponding decrease to the liability for maintenance account.
MSAF Group will only reimburse the lessee for the cost of maintenance
expenditures to the extent that sufficient prepayments have been made by the
lessee. At the time an aircraft is re-leased to a new lessee, an assessment is
made of the expected maintenance reserve requirements; any excess reserve is
then released to lease income. In the quarter ended May 31, 1999, MSAF Group
released $1.4 million of excess maintenance reserves which were received from
certain of its former lessees.

     INVESTMENT INCOME

     Investment income for the three month period ended May 31, 1999 amounted to
$0.5 million as compared to $1.0 million in the three month period ended May 31,
1998. Investment income represents interest income on MSAF Group's cash and cash
equivalents.

     Investment income has declined as the excess cash held in March 1998 was
utilized to acquire an additional aircraft during Fiscal 1998, as well as the
return of excess cash to investors in respect of an undelivered aircraft.

     INTEREST EXPENSE

     Interest expense, including swap costs of $2.1 million, amounted to $16.0
million for the three month period ended May 31, 1999. Interest expense,
including swap costs of $0.5 million, amounted to $16.7 million for the three
month period ended May 31, 1998. Interest expense relates to the cost of the
Notes which were
                                       15
<PAGE>   17

issued on March 3, 1998. The decline in interest expense is due to lower
interest rates and principal balances of the Notes for the three month period
ended May 31, 1999. The weighted average interest rate on the Subclass A-1 to
D-1 Notes during the three month period ended May 31, 1999 was 5.81% and during
the three month period ended May 31, 1998 was 6.36%. The average debt in respect
of the Subclass A-1 to D-1 Notes during the three month period ended May 31,
1999 was $965.6 million, and the three month period ended May 31, 1998 was
$1,042.0 million.

     MSAF Group is a party to eight interest rate swaps with Morgan Stanley
Capital Services Inc. ("MSCS"), a wholly-owned subsidiary of MSDW. In six of
these swaps, MSAF Group pays a fixed monthly coupon and receives one month LIBOR
on a notional balance of $1,000 million and in two of these swaps, MSAF Group
pays one month LIBOR and receives a fixed monthly coupon on a notional balance
of $200 million.

     All eight swaps were originally entered into by MSCS, with an internal
swaps desk as the counterparty, on November 12, 1997 and February 19, 1998,
respectively. On March 3, 1998, all eight swaps were assigned to MSAF Group by
MSCS and on such date such swaps had an aggregate fair value of approximately
$(15.3) million. No consideration was paid to or received by MSAF Group in
connection with the assumption of these swap positions. MSAF Group has recorded
the assumption of these interest rate swaps at their fair value by recognizing a
liability within Other liabilities in its Interim Condensed Consolidated Balance
Sheets, with a corresponding charge to Deemed Distribution, a component of
Beneficial Interestholder's Deficit.

     Four of the swaps assumed from MSCS having an aggregate notional principal
amount of $800 million are accounted for as hedges of its obligations under the
Notes. Under these swap arrangements MSAF Group will pay fixed and receive
floating amounts on a monthly basis. The fair value of the liability assumed
relating to those swaps which are being accounted for as hedges is being
deferred and recognized when the offsetting gain or loss is recognized on the
hedged transaction. This amount and the differential payable or receivable on
such interest rate swap contracts, to the extent such swaps are deemed to be
effective hedges for accounting purposes, are recognized as an adjustment to
interest expense. The portion of these swaps not deemed to be effective hedges
for accounting purposes are accounted for on a mark-to-mark basis with changes
in fair value reflected in interest expense.

     The remaining four swaps assumed by MSAF Group have an aggregate gross
notional principal amount of $400 million. Under these swap arrangements, MSAF
Group will pay/receive fixed and receive/pay floating amounts on a monthly
basis. MSAF Group determined that these swaps do not qualify for hedge
accounting. The fair value of the liability assumed related to these swaps is
accounted for on a mark-to-market basis with changes in fair value reflected in
interest expense.

     Notwithstanding the different accounting treatments for the various swaps,
all eight swaps were required to hedge MSAF Group's interest rate exposure on an
economic basis. In November 1997, MSAF Group had contracted to purchase the
aircraft and their associated fixed rate leases but, prior to the time of
pricing the Notes, was exposed to movements in interest rates with respect to
its anticipated liabilities under the Notes. Accordingly, in November 1997, six
swaps with a notional balance of $1,000 million were entered into by MSCS under
which MSAF Group would pay fixed amounts and receive floating amounts. Once the
Notes were priced in February 1998, MSAF Group could determine that to hedge the
interest rate exposure associated with its variable rate debt it required swaps
with a notional balance of approximately $800 million. Accordingly, in February
1998, MSCS entered into re-balancing swaps with a notional amount of $200
million under which MSAF Group would pay floating amounts and receive fixed
amounts.

     The net economic effect of assigning all eight swaps with a gross notional
amount of $1.2 billion to MSAF Group on March 3, 1998 was to fix MSAF Group's
interest rate liability at November 12, 1997, shortly after the date MSAF Group
incurred its exposure to movements in interest rates when it agreed to purchase
the aircraft with associated fixed rate leases. See "Interest Rate Risk
Management" below for more information regarding MSAF Group's swaps positions
and hedging policy.

                                       16
<PAGE>   18

     DEPRECIATION

     Depreciation expense for the three month period ended May 31, 1999 amounted
to $11.8 million, as compared to $11.5 million in the three month period ended
May 31, 1998.

     OPERATING EXPENSES

     Service Provider and Other Fees.  Service provider and other fees for the
three month period ended May 31, 1999 were $2.2 million as compared to $2.8
million in the three month period ended May 31, 1998. The most significant
element in both periods was the aircraft servicing fee paid to ILFC which
amounted to $1.3 million in the three month period ended May 31, 1999 and $0.9
million in the three month period ended May 31, 1998. The higher servicing fee
in Fiscal 1999 reflects an increase in the annual base fee payable to ILFC. MSAF
Group's service provider expenses also included $0.5 million in respect of
administrative agency and cash management fees in the three months ended May 31,
1999 as compared to $0.4 million in the three months ended May 31, 1998.

     Maintenance and Other Aircraft Related Costs.  Maintenance and other
aircraft related costs amounted to $1.9 million for the three month periods
ended May 31, 1999 and 1998. The expense for the quarter ended May 31, 1999
includes certain maintenance and redelivery costs incurred by MSAF Group
associated with an aircraft previously leased to Guyana Airways. Such costs were
necessary to prepare the aircraft for a new lessee (see "LESSEE DIFFICULTIES").

     Included within maintenance and other aircraft related costs were
insurance, re-leasing and other costs incurred in the three month period ended
May 31, 1999, which amounted to approximately $0.5 million, as compared to $0.4
million for the three month period ended May 31, 1998. It is expected that
re-leasing costs will increase over the next several months due to costs
relating to reconfiguring aircraft for new lessees upon redelivery.

RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED MAY 31, 1999,
AND THE SIX MONTHS ENDED MAY 31, 1998

     MSAF Group's results of operations for the six months ended May 31, 1999
are not directly comparable to those of the six months ended May 31, 1998 as
MSAF Group did not own its aircraft portfolio throughout the entire six month
period ended May 31, 1998. In addition, the Notes were issued on March 3, 1998
and accordingly, MSAF Group did not have any interest expense for the first
three months of the six month period ended May 31, 1998.

     NET (LOSS)/INCOME

     For the six month period ended May 31, 1999 MSAF Group incurred a net loss
of $3.2 million as compared to net income of $18.8 million for the six month
period ended May 31, 1998. The decrease primarily reflects higher interest and
depreciation expenses.

     LEASE INCOME

     Lease income for the six month period ended May 31, 1999 amounted to $59.1
million as compared to $57.8 million for the six month period ended May 31,
1998. MSAF Group's operating results for the six month period ended May 31, 1999
were adversely affected by provisions for doubtful accounts aggregating $6.0
million. Such provisions were recorded by MSAF Group due to financial
difficulties experienced by certain of its current lessees, as well as to
reserve against amounts owed to MSAF Group by certain of its former lessees
whose aircraft have already been repossessed (see "LESSEE DIFFICULTIES"). No
provisions for doubtful accounts were recorded in the six month period ended May
31, 1998.

     INVESTMENT INCOME

     Investment income amounted to $1.0 million in the six month periods ended
May 31, 1999 and 1998.

                                       17
<PAGE>   19

     INTEREST EXPENSE

     Interest expense, including swap costs of $2.9 million, amounted to $32.4
million for the six month period ended May 31, 1999. Interest expense, including
swap costs of $0.5 million, amounted to $16.7 million for the six month period
ended May 31, 1998. The decrease reflects that MSAF Group did not issue the
Notes until March 1998. The weighted average interest rate on the Subclass A-1
to D-1 Notes during the six month period ended May 31, 1999 was 6.05% and the
average debt in respect of the Subclass A-1 to D-1 Notes outstanding during the
six month period ended May 31, 1999 was $969.7 million.

     DEPRECIATION

     Depreciation expense for the six month period ended May 31, 1999 amounted
to $23.5 million, as compared to $15.3 million in the six month period ended May
31, 1998. The increase in Fiscal 1999 reflects that MSAF Group did not own all
of the aircraft throughout the entire six month period ended May 31, 1998.

     OPERATING EXPENSES

     Service Provider and Other Fees.  Service provider and other fees for the
six month period ended May 31, 1999 were $4.3 million as compared to $5.7
million for the six month period ended May 31, 1998. The most significant
element in both periods was the aircraft servicing fee paid to ILFC, which
amounted to $2.7 million in the six month period ended May 31, 1999, and $3.8
million in the six month period ended May 31, 1998. The fee paid in the six
month period ended May 31, 1998 included an initial upfront fee of $2.0 million
paid to ILFC at the inception of the Servicing Agreement. MSAF Group's service
provider expenses also included $0.8 million in respect of administrative agency
and cash management fees in the six months ended May 31, 1999 as compared to
$0.4 million in the six months ended May 31, 1998. These fees were lower in the
six month period ended May 31, 1998 as MSAF Group did not own all of the
aircraft throughout that period.

     Maintenance and Other Aircraft Related Costs.  Maintenance and other
aircraft related costs for the six month period ended May 31, 1999 amounted to
$3.0 million as compared to $2.3 million for the six month period ended May 31,
1998.

     Included within maintenance and other aircraft related costs were
insurance, re-leasing and other costs incurred in the six month period ended May
31, 1999, which amounted to approximately $1.1 million, as compared to $0.4
million for the six month period ended May 31, 1998. The increase reflects a
higher level of re-leasing events during the six month period ended May 31,
1999. It is expected that re-leasing costs will increase over the next several
months due to costs relating to reconfiguring aircraft for new lessees upon
redelivery.

FINANCIAL RESOURCES AND LIQUIDITY

     Refer to Appendix 1 for additional information regarding the cash
performance of MSAF Group for the period from February 17, 1999 to May 17, 1999.

     LIQUIDITY

     MSAF Group's cash and cash equivalents at May 31, 1999 were $37.4 million.
Of this amount, $25 million represents the cash portion of the Liquidity Reserve
Amount (as defined below) and $12.4 million represents rental and maintenance
receipts and cash held for accrued expenses.

     In addition to the $25 million cash portion at May 31, 1999, the Liquidity
Reserve Amount also contained $41.1 million of undrawn credit and liquidity
facilities from MSDW and ILFC.

     CASH FLOWS FROM OPERATING ACTIVITIES

     Operating cash flows depend on many factors including the performance of
lessees and MSAF Group's ability to re-lease aircraft, the average interest
rates of the Notes, the effectiveness of MSAF Group's interest

                                       18
<PAGE>   20

rate hedging policies and whether MSAF Group will be able to refinance certain
subclasses of Notes that may not be repaid with lease cash flows.

     Net cash provided by operating activities for the six month period ended
May 31, 1999 amounted to $22.4 million, principally reflecting non-cash
depreciation expense of $23.5 million, a net loss of ($3.2) million and
provision for doubtful accounts of $6.0 million.

     Net cash provided by operating activities for the six month period ended
May 31, 1998 amounted to $55.8 million, principally reflecting net income of
$18.8 million, non-cash depreciation expense of $15.3 million, an increase in
the liability for maintenance of $7.1 million and an increase in deferred rental
income of $7.5 million.

     CASH FLOWS FROM INVESTING AND FINANCING ACTIVITIES

     In the six month period ended May 31, 1999, MSAF Group did not utilize any
cash for investing activities, while in the six month period ended May 31, 1998,
the use of cash flows for investing activities of $887.3 million was to acquire
aircraft.

     In the six month period ended May 31, 1999, $19.9 million of cash for
financing activities was used to repay principal on the Notes, while in the six
month period ended May 31, 1998, cash flows from financing activities were
$894.4 million, reflecting the proceeds from the Notes and the repayment of
borrowings from MSF.

     INDEBTEDNESS

     MSAF Group's indebtedness primarily consisted of the Subclass A-1 to D-1
Notes in the amount of $959.0 million at May 31, 1999.

     LIQUIDITY RESERVE AMOUNT

     The "LIQUIDITY RESERVE AMOUNT" is intended to serve as a source of
liquidity for MSAF Group's maintenance obligations, security deposit return
obligations, operating expenses, contingent liabilities and Note obligations.
The Liquidity Reserve Amount may be funded with cash and letters of credit,
guarantees or other credit support instruments ("ELIGIBLE CREDIT FACILITIES")
provided by, or supported with further Eligible Credit Facilities provided by, a
person (an "ELIGIBLE PROVIDER") whose short-term unsecured debt is rated P-1 by
Moody's Investors Service, A-1 by Standard & Poor's, or D-1 by Duff & Phelps
or is otherwise designated as an Eligible Provider by the Controlling Trustees.
Both the ILFC facility discussed below under "-- ILFC Facility" and the MSDW
facility discussed below under "-- MSDW Facility" are Eligible Credit Facilities
and comprise part of the Liquidity Reserve Amount. There are currently no other
Eligible Credit Facilities in place.

     The Liquidity Reserve Amount was approximately $66.1 million on May 31,
1999. The "MINIMUM LIQUIDITY RESERVE AMOUNT" may be funded with cash and with
Eligible Credit Facilities and was approximately $15 million on May 31, 1999.
The Liquidity Reserve Amount and the Minimum Liquidity Reserve Amount may be
increased or decreased from time to time for any reason (including upon
acquisitions of additional aircraft) by an action of the Controlling Trustees in
light of changes in, inter alia, the condition of the Aircraft, the terms and
conditions of the leases, the financial condition of the lessees, sales of
aircraft and prevailing industry conditions; provided that MSAF Group will
obtain confirmation in advance in writing from the rating agencies that any
proposed reduction in the Liquidity Reserve Amount or the Minimum Liquidity
Reserve Amount will not result in a lowering or withdrawal by any of the rating
agencies of their respective ratings of any Notes.

     If the balance of cash on deposit, together with the amount available for
drawing under any Eligible Credit Facilities, should fall below the Liquidity
Reserve Amount at any time (including as a result of MSAF Group's determination
that the Liquidity Reserve Amount should be increased, as required by the rating
agencies or otherwise), MSAF Group may continue to make all payments, and any
credit or liquidity enhancement facilities may be drawn to fund such payments,
including required payments on the Notes,
                                       19
<PAGE>   21

which rank prior to, or equally with, payments of the minimum principal payment
amount on the class D Notes under the Indenture and any Permitted Accruals other
than in respect of Modification Payments, provided that the balance of cash on
deposit, together with the amount available for drawing under any Eligible
Credit Facilities, does not fall below the Minimum Liquidity Reserve Amount at
its then current level. "MODIFICATION PAYMENTS" are any capital expenditures for
the purpose of effecting any optional improvement or modification of any
aircraft, or for the optional conversion of any aircraft from a passenger
aircraft to a freighter or mixed-use aircraft, for the purpose of purchasing or
otherwise acquiring any engines or parts outside of the ordinary course of
business. "PERMITTED ACCRUALS" are amounts in respect of expenses and costs that
are not regular, monthly recurring expenses, including Modification Payments and
refinancing expenses, if any, anticipated to become due and payable in any
future interest accrual period. However, the balance of cash on deposit,
together with the amount available for drawing under any Eligible Credit
Facilities, may fall below the Minimum Liquidity Reserve Amount at its then
current level and MSAF Group may continue to make payments of, and any credit or
liquidity enhancement facilities may be drawn to fund such payments, all accrued
and unpaid interest on any subclass of the most senior class of Notes then
outstanding to avoid an event of default, with respect to the Notes and, on the
final maturity date of any subclass thereof, principal of, any subclass of the
most senior class of Notes then outstanding to avoid an event of default with
respect to the Notes.

     Amounts drawn under any Eligible Credit Facility will either be repayable
at the third level in the priority of payments, as set forth in the Indenture
before the First Collection Account Top-Up (any such facility, a "PRIMARY
ELIGIBLE CREDIT FACILITY") or at the 11th level in the priority of payments,
before the Second Collection Account Top-Up (any such facility, a "SECONDARY
ELIGIBLE CREDIT FACILITY"). The "FIRST COLLECTION ACCOUNT TOP-UP" is the amount,
if positive, equal to (A) the Minimum Liquidity Reserve Amount less (B) amounts
available for drawing under any Primary Eligible Credit Facilities. The "SECOND
COLLECTION ACCOUNT TOP-UP" is the amount, if positive, equal to (A) the
Liquidity Reserve Amount less (B) an amount equal to cash amounts reserved at
the third level in the priority of payments plus amounts available for drawing
under any Eligible Credit Facilities.

     The Liquidity Reserve Amount and the Minimum Liquidity Reserve Amount have
been determined largely based on an analysis of historical experience,
assumptions regarding MSAF Group's future experience and the frequency and cost
of certain contingencies in respect of the aircraft currently owned by MSAF
Group, and are intended to provide liquidity for meeting the cost of maintenance
obligations and non-maintenance, aircraft-related contingencies such as removing
regulatory liens, complying with airworthiness directives (AD's), repossessing
and releasing aircraft. In analyzing the future impact of these costs,
assumptions have been made regarding their frequency and amount based upon
historical experience. There can be no assurance, however, that historical
experience will prove to be relevant in the future or that actual cash received
by MSAF Group in the future will not be significantly less than that assumed.
Any significant variation may materially adversely affect the ability of MSAF
Group to make payments of interest and principal on the Notes.

     ILFC FACILITY

     Under the ILFC facility, ILFC will hold certain security deposits with
respect to the aircraft currently owned by MSAF Group as custodian for the
benefit of the MSAF Group. ILFC will hold all cash security deposits paid with
respect to the aircraft in MSAF Group's initial portfolio other than, (i)
amounts determined in good faith by ILFC to be no longer held on behalf of a
lessee, whether upon expiry of or default under the applicable lease or
otherwise, and (ii) any cash security deposits in an amount exceeding three
months' rent with respect to a single aircraft and paid by a single lessee. Any
interest accruing on amounts of aircraft security deposits that are being held
by ILFC will generally accrue for the benefit of ILFC.

     In addition, under the ILFC facility, ILFC will make loans to MSAF Group
which MSAF Group may use for the same purposes as those for which the Liquidity
Reserve Amount may be applied as discussed above under "-- Liquidity Reserve
Amount," including to pay interest and minimum principal payment amounts payable
under the Indenture on the Notes. ILFC's obligation to make such amounts
available shall be limited to the ILFC facility commitment which was
approximately $31.1 million on May 31, 1999. The ILFC facility
                                       20
<PAGE>   22

commitment shall be equal to, (i) at any time before an early termination of the
Servicing Agreement for a reason other than a sale of all the aircraft in MSAF
Group's current portfolio or the repayment or defeasance of MSAF Group's debt (a
"FACILITY REDUCTION EVENT"), the sum of, (A) $10 million plus, (B) total
security deposits held by ILFC for the benefit of MSAF Group at such time minus,
(C) all drawings previously made by MSAF Group under the ILFC facility and
required to be repaid to ILFC but not repaid at such time, and (ii) at any time
from and after a Facility Reduction Event, $10 million minus all ILFC facility
drawn amounts required to be repaid to ILFC but not repaid at such time.

     The ILFC facility is a Secondary Eligible Credit Facility and, accordingly,
on the Note payment date following any drawing on the ILFC facility, MSAF Group
will be obligated, to the extent there are available collections remaining after
payment of the minimum principal payment amount on the class D Notes under the
Indenture, to repay ILFC facility drawn amounts to ILFC, together with interest
accrued thereon at 3% per annum, calculated on the basis of a 360-day year
consisting of twelve 30-day months and compounded daily.

     ILFC's agreement to provide the ILFC facility will expire on the earliest
of, (i) May 26, 2023, (ii) a sale of all the aircraft, and (iii) the repayment
or defeasance of all MSAF Group's debt.

     At any time and for so long as ILFC is not an Eligible Provider, ILFC's
obligations under the ILFC facility will be supported by an Eligible Credit
Facility satisfactory to MSAF Group provided by an Eligible Provider at ILFC's
expense (a "BACK-UP FACILITY").

     MSAF Group may borrow under the ILFC facility, (i) in order to pay interest
and minimum principal payment amounts on the Notes, (ii) upon a downgrade in the
short-term unsecured debt rating of the provider of the Back-Up Facility such
that it is no longer an Eligible Provider, and (iii) upon failure by the
provider of the Back-Up Facility to renew the Back-Up Facility (the events
described in clause (ii) and (iii), each, a "SUSPENSION EVENT"). If for any
reason ILFC fails to make any loan requested when due, MSAF Group may draw on
the Back-Up Facility.

     In the event of a loan by ILFC, or a drawing on the Back-Up Facility, in a
Suspension Event (a "SUSPENSION DRAWING"), MSAF Group will hold the drawing
proceeds and such proceeds will comprise part of the cash portion of the
Liquidity Reserve Amount. In the event of any drawing, the obligation to
reimburse the provider of the Back-Up Facility shall be solely ILFC's obligation
and the provider of the Back-Up Facility shall have no recourse to MSAF Group
for any such amounts that are not reimbursed by ILFC.

     Immediately following and after giving effect to any Suspension Drawing,
ILFC shall set off and apply the security deposits held by it on the date of
such Suspension Drawing on MSAF Group's behalf against the principal amount of
any ILFC facility drawn amounts then outstanding, which shall be deemed repaid
in the amount of such set-off and application. After giving effect to such
set-off and application, MSAF Group shall be obliged to repay only up to $10
million of any outstanding ILFC facility drawn amounts unless and until ILFC has
procured, at its expense, a replacement Back-Up Facility acceptable to MSAF
Group. MSAF Group shall be obliged to pay interest on the proceeds of a
Suspension Drawing at 3% per annum, calculated on the basis of a 360-day year
consisting of twelve 30-day months and compounded daily.

     MSDW FACILITY

     Under the MSDW facility, MSDW will make loans to MSAF Group which MSAF
Group may use for the same purposes as those for which the Liquidity Reserve
Amount may be applied as discussed above under "-- Liquidity Reserve Amount,"
including to pay interest and minimum principal payment amounts on the Notes.
MSDW's obligation to make such amounts available shall be limited to the MSDW
facility commitment. The MSDW facility commitment, at any time, shall be equal
to the sum of, (A) $10 million minus, (B) all drawings previously made by MSAF
Group under the MSDW facility and not repaid at such time.

     The MSDW facility is a Secondary Eligible Credit Facility and, accordingly,
on the Note payment date following any drawing on the MSDW facility, MSAF Group
will be obligated, to the extent that there are
                                       21
<PAGE>   23

Available Collections remaining after payment of the minimum principal payment
amount on the class D Notes, to repay MSDW facility drawn amounts to MSDW,
together with interest accrued thereon at 3% per annum, calculated on the basis
of a 360-day year consisting of twelve 30-day months and compounded daily.

     MSDW's agreement to provide the MSDW facility will expire on the earlier
of, (i) a sale of all the aircraft, and (ii) the repayment or defeasance of all
MSAF Group's debt. MSDW has been designated by the Controlling Trustees as an
Eligible Provider. MSDW's long-term unsecured debt is currently rated Aa3 by
Moody's, A+ by Standard & Poor's and AA by Duff & Phelps.

     OTHER FACILITIES

     There are currently no Primary Eligible Credit Facilities in place. MSAF
Group may put in place other Eligible Credit Facilities from time to time, each
of which shall be designated by the Controlling Trustees as a Primary Eligible
Credit Facility or a Secondary Eligible Credit Facility. In addition, MSAF Group
may from time to time put in place other credit or liquidity enhancement
facilities which are not Eligible Credit Facilities. Amounts drawn under any
such other facilities are repayable at the 11th level in the order of
priorities, before the Second Collection Account Top-Up.

     YEAR 2000 READINESS

     Many existing computer systems use only two digits to identify a year in
the date field. These systems were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results by or at the year
2000. We have begun a process of assessing the potential impact of the year 2000
issue on our operations. Since substantially all of our operational functions
have been delegated to the Servicer we have no information systems of our own.
We may, however, suffer a material adverse impact on our business and results of
operations if information technology upon which the lessees and ILFC rely is not
year 2000 compliant.

     The administrative agent, cash manager and financial advisor each are
reviewing their year 2000 exposure and identifying the steps that will need to
be taken to ensure that their systems are year 2000 compliant. If the
administrative agent's or financial advisor's systems are not fully year 2000
compliant, we do not expect the consequences of such noncompliance to have a
material adverse effect on our business. MSAF Group may suffer a material
adverse impact on its business and results of operations if information
technology upon which the cash manager relies is not year 2000 compliant.

     ILFC has assessed its computer and information systems to determine the
extent of its exposure to year 2000 risks. ILFC believes that all of its
critical computer and information systems were year 2000 compliant as of
September 30, 1998. ILFC is conducting a survey of the critical third parties
with which it conducts business on our behalf to determine the extent of their
exposure to year 2000 risks and the status of their year 2000 compliance
efforts. As of July 1, 1999, ILFC has received responses from all but three of
MSAF Group's 29 current lessees. Based on these responses, ILFC has indicated to
MSAF Group that approximately two-thirds of the lessees are or will be year 2000
compliant by August 1999. ILFC is engaged in an ongoing dialog with noncompliant
lessees and continues to attempt to contact the three lessees that have not yet
responded. Nonetheless, significant uncertainties remain regarding the status of
year 2000 compliance efforts of critical third parties and the risks to MSAF
Group of noncompliance by such third parties.

     Noncompliance by a lessee could result in lost revenue for the lessee and
an inability to make lease payments to MSAF Group. Noncompliance by the lessee's
financial institutions could also adversely affect the ability to process lease
payments. ILFC, on behalf of MSAF Group, has inquired of each lessee about
whether it has addressed year 2000 compliance issues with its financial
institutions.

     Our worst case scenario would be that a large number of lessees are unable
to operate their aircraft and generate revenues and as a result are unable to
make lease payments to MSAF Group. MSAF Group is unable to determine at this
time the likelihood or magnitude of any resulting lost revenue or whether the
consequences of year 2000 failures will have a material impact on MSAF Group's
business or financial position.
                                       22
<PAGE>   24

     If a noncompliant lessee cannot operate its aircraft and cannot make
contractual lease payments due to year 2000 issues, our contingency plans may
include for ILFC to repossess aircraft from lessees in default and then attempt
to re-lease such aircraft to a year 2000 compliant lessee. We cannot assure that
ILFC would be able to re-lease such aircraft at favorable terms or at all or
that there may not be a significant delay in re-leasing. If a significant number
of aircraft could not be re-leased at favorable terms or at all, it may have a
material adverse effect on our business.

     Aircraft and air traffic control systems also depend heavily on
microprocessors and software technology. If the systems employed by the aircraft
are not year 2000 compliant, our business and results of operations may be
adversely affected. Major aircraft manufacturers, including Boeing and Airbus,
are conducting year 2000 reviews of the systems employed on their aircraft and
are advising owners, operators and service providers of the steps to be taken to
address any year 2000 problems that are identified. According to Boeing's most
recent public disclosure, Boeing believes that its systems will be 100%
compliant by July 31, 1999. Among the aircraft systems that have been identified
as being susceptible to year 2000 problems are certain on-board aircraft
management and navigation systems. The nature and extent of the risks posed by
potential failure of aircraft and aircraft control systems because of year 2000
problems has not been fully determined. We cannot assure that our lessees will
follow the advice of aircraft manufacturers regarding the steps to be taken to
address year 2000 compliance. It is not clear whether or to what extent
manufacturers, owners or lessees will be responsible for the costs necessary to
make aircraft systems year 2000 compliant. Accordingly, MSAF Group is currently
not able to make any estimate of the amount, if any, it may be required to spend
to remediate year 2000 problems associated with the aircraft. Such expenditures
could, however, have a material adverse impact on the ability of MSAF Group to
make payments on the Notes.

     The aviation insurance markets have sought to exclude any claims for losses
incurred as a result of year 2000 problems under existing policies. However, the
application of this exclusion may be mitigated by the availability of the
following limited writeback endorsements ("YEAR 2000 ENDORSEMENTS"): (i) hull
and aircraft liability coverage in respect of accidental loss of damage to
insured aircraft and for liability arising out of an accident involving the
insured aircraft as a result of a year 2000 occurrence and (ii) non aircraft
liability coverage with regard to liability caused by an accident and arising
out of a risk insured under the policy as a result of year 2000 failure.
Therefore, the effect of the Year 2000 Endorsements is to provide that losses
(including consequential losses) arising from a year 2000 failure will only be
paid where they result from an accident involving an aircraft or an injury to a
third party. Insurers will provide Year 2000 Endorsements to those airlines
which satisfy insurers that they have identified and are adequately addressing
the year 2000 issues affecting that airline. As of July 1, 1999, all but two of
MSAF Group's current lessees have obtained Year 2000 Endorsements. MSAF Group,
in conjunction with ILFC and its insurance brokers, continues to assess the year
2000 status of its lessees' aviation insurance.

     The Year 2000 Endorsements are currently available to MSAF Group in respect
of any of its off-lease aircraft. In addition, MSAF Group maintains contingent
insurance designed to protect the lessor in circumstances where the lessor fails
to collect from the insurances required to be provided by the lessee. In respect
of any insured claims for losses incurred as a result of year 2000 problems,
MSAF Group's contingent insurances are not available if the operator's policy
does not contain Year 2000 Endorsements.

                                       23
<PAGE>   25

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE SENSITIVITY

     MSAF Group's principal market risk exposure is to changes in interest
rates. This exposure arises from its Notes and the derivative instruments used
to manage interest rate risk.

     The terms of each subclass of the Notes, including the outstanding
principal amount and estimated fair value as of May 31, 1999 are as follows:

<TABLE>
<CAPTION>
                          OUTSTANDING
                        PRINCIPAL AMOUNT        ANNUAL                                               FAIR VALUE
SUBCLASS OF                AT MAY 31,        INTEREST RATE       EXPECTED FINAL     FINAL MATURITY   AT MAY 31,
NOTE                          1999         (PAYABLE MONTHLY)      PAYMENT DATE           DATE           1999
-----------             ----------------   -----------------   ------------------   --------------   ----------
                            ($000'S)                                                                  ($000'S)
<S>                     <C>                <C>                 <C>                  <C>              <C>
Subclass A-1.........       $400,000         LIBOR + 0.21%         March 15, 2000   March 15, 2023    $399,320
Subclass A-2.........        256,056         LIBOR + 0.35%     September 15, 2005   March 15, 2023     254,673
Subclass B-1.........         92,942         LIBOR + 0.65%         March 15, 2013   March 15, 2023      89,001
Subclass C-1.........        100,000                 6.90%         March 15, 2013   March 15, 2023      90,250
Subclass D-1.........        110,000                 8.70%         March 15, 2014   March 15, 2023     103,400
</TABLE>

INTEREST RATE RISK MANAGEMENT

     The leasing revenues of MSAF Group are generated primarily from rental
payments. Rental payments are currently entirely fixed but may be either fixed
or floating with respect to future leases. In general, an interest rate exposure
arises to the extent that MSAF Group's fixed and floating interest obligations
in respect of the Notes do not correlate to the mix of fixed and floating rental
payments for different rental periods. This interest rate exposure can be
managed through the use of interest rate swaps and other derivative instruments.
The subclass A-1, A-2 and B-1 Notes bear floating rates of interest and the
subclass C-1 and D-1 Notes bear fixed rates of interest.

     MSAF Group is a party to eight interest rate swaps (the "INITIAL SWAPS")
with MSCS. In six of these swaps MSAF Group pays a fixed monthly coupon and
receives one month LIBOR and in two of these swaps MSAF Group pays one month
LIBOR and receives a fixed monthly coupon on the notional balances as set out
below:

<TABLE>
<CAPTION>
                                                                                        FAIR VALUE
NOTIONAL                                              FIXED MONTHLY    FIXED MONTHLY    AT MAY 31,
BALANCE      EFFECTIVE DATE        MATURITY DATE        PAY RATE       RECEIVE RATE        1999
--------    -----------------    -----------------    -------------    -------------    ----------
($000'S)                                                   (%)              (%)          ($000'S)
<S>         <C>                  <C>                  <C>              <C>              <C>
 100,000    November 12, 1997    November 15, 1999       6.0550               --            (389)
 300,000    November 12, 1997    November 15, 2000       6.1325               --          (2,076)
 200,000    November 12, 1997    November 15, 2002       6.2150               --          (1,160)
 200,000    November 12, 1997    November 15, 2004       6.2650               --            (905)
 150,000    November 12, 1997    November 15, 2007       6.3600               --            (809)
  50,000    November 12, 1997    November 15, 2009       6.4250               --            (337)
 150,000    February 19, 1998    November 15, 2007           --            5.860          (4,154)
  50,000    February 19, 1998    November 15, 2009           --            5.905          (1,668)
</TABLE>

     All eight swaps were originally entered into by MSCS with an internal swaps
desk as the counterparty on November 12, 1997 and February 19, 1998,
respectively. On March 3, 1998, all eight of the above swaps were assigned to
MSAF Group by MSCS. Although MSAF Group's floating rate liability March 3, 1998
was approximately $800 million (after the repayment of principal due to the
undelivered aircraft), the net economic effect of assigning all eight swaps to
MSAF Group with an aggregate notional amount of $1.2 billion was to fix the
interest rate liability at the November 12, 1997 interest rate. MSAF Group
required this certainty both in furtherance of its interest rate management
policy not to be adversely exposed to material movements in interest rates from
November 12, 1997 (shortly after MSAF Group entered into the asset
                                       24
<PAGE>   26

purchase agreement with ILFC for the acquisition of the aircraft and related
fixed rate leases) and, by fixing the principal liabilities relating to the
transaction, to facilitate the structuring of the transaction.

     MSAF Group regularly reviews its hedging requirements. In the future MSAF
Group expects to seek to enter into additional swaps or sell at market value or
unwind part or all of the initial and any future swaps in order to rebalance the
fixed and floating mix of interest obligations (including those arising as a
result of previous interest rate swaps entered into) and the fixed and floating
mix of rental payments.

     Through the use of interest rate swaps, and other interest rate hedging
products, it is MSAF Group's policy not to be adversely exposed to material
movements in interest rates. MSAF Group's interest rate management strategy will
need to be rebalanced with any acquisition of additional aircraft to reflect the
adjusted mix of fixed and floating rate rental payments arising from any such
acquisition. There can be no assurance, however, that MSAF Group's interest rate
risk management strategies will be effective in this regard. Any change to MSAF
Group's policy with regard to its dealing in interest rate hedging products will
be subject to periodic review by the rating agencies.

     The Controlling Trustees are responsible for reviewing and approving the
overall interest rate management policies and transaction authority limits.
Counterparty risk will be monitored on an ongoing basis. Counterparties will be
subject to the prior approval of the Controlling Trustees. MSAF Group's
counterparties are currently all affiliates of MSDW. Future counterparties will
consist primarily of the affiliates of major United States and European
financial institutions (including special-purpose derivative vehicles) which
have credit ratings, or which provide collateralization arrangements, consistent
with maintaining the ratings of the Notes.

     The change in the fair value of the eight swaps between November 30, 1998
and May 31, 1999 was primarily due to changes in market interest rates.

                                       25
<PAGE>   27

                          PART II.  OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

     (a)  Exhibits

        27.1 Financial Data Schedule.

     (b)  Reports on Form 8-K: Morgan Stanley Aircraft Finance filed a Current
          Report on Form 8-K dated March 11, 1999, April 14, 1999 and May 13,
          1999 relating to the monthly report to holders of the Notes.

                                       26
<PAGE>   28

                                   SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

Date: July 14, 1999
                                          MORGAN STANLEY AIRCRAFT FINANCE

                                          By:      /s/ ALEXANDER FRANK
                                            ------------------------------------
                                                      Alexander Frank
                                                     Signatory Trustee

                                       27
<PAGE>   29

                        MORGAN STANLEY AIRCRAFT FINANCE

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C>        <S>
 27.1      Financial Data Schedule
</TABLE>

                                       28
<PAGE>   30

                                                                      APPENDIX 1

                        MORGAN STANLEY AIRCRAFT FINANCE

              MANAGEMENT DISCUSSION & ANALYSIS OF CASH PERFORMANCE

I. BACKGROUND AND GENERAL INFORMATION

     On March 3, 1998, Morgan Stanley Aircraft Finance ("MSAF"), a Delaware
business trust, issued $1,050 million of Notes in five subclasses -- Subclass
A-1, Subclass A-2, Subclass B-1, Subclass C-1 and Subclass D-1 (the "NOTES").
The Notes were issued in connection with MSAF's agreement to acquire 33 aircraft
plus a spare engine with a total appraised value at September 30, 1997 of
$1,115.51 million from International Lease Finance Corporation ("ILFC").

     All but one of the 33 aircraft were acquired by MSAF. The undelivered
aircraft was a B737 with an appraised value of $28.82 million. Pursuant to the
indenture relating to the Notes (the "INDENTURE"), MSAF decided not to
substitute this aircraft but to distribute to Noteholders $26.0 million which
represents that portion of the proceeds from the offering of the Notes relating
to this aircraft on June 15, 1998. As a result, the overall size of the aircraft
fleet is now 32 aircraft plus a spare engine and the appraised value of the
fleet was reduced from $1,115.51 million to $1,086.69 million at September 30,
1997.

     The fleet is appraised annually and the appraised value of the fleet at
September 30, 1998 was $1,029.4 million. Applying the declining value assumption
to the original September 30, 1997 fleet appraisal, the total appraised value
was assumed to be $1,047.9 million at May 17, 1999. See "Aircraft Values" below.
As of July 1, 1999, all 32 aircraft plus the engine were subject to leases with
29 lessees in 19 countries.

     The discussion and analysis, which follows, is based on the results of MSAF
and its subsidiaries as a single entity (collectively the "MSAF GROUP").

     MSAF Group is a special purpose vehicle which owns aircraft subject to
operating leases and, in one certain instance, a finance lease. MSAF Group may
also make aircraft acquisitions and aircraft sales. MSAF intends to acquire
additional commercial passenger or freight aircraft from various sellers and
will finance the acquisition of such aircraft by issuing additional notes. Any
acquisition of further aircraft will be subject to certain confirmations with
respect to the Notes from rating agencies and compliance with certain operating
covenants of MSAF set out in the Indenture.

     MSAF Group's cash receipts and disbursements are determined, in part, by
the overall economic condition of the operating leasing market. The operating
leasing market, in turn, is affected by various cyclical factors including
interest rates, the availability of credit, fuel costs and general and regional
economic conditions affecting lessee operations and trading; manufacturer
production levels; passenger demand; retirement and obsolescence of aircraft
models; manufacturers exiting or entering the market or ceasing to produce
aircraft types; re-introduction into service of aircraft previously in storage;
governmental regulation; and air traffic control infrastructure constraints such
as limitations on the number of landing slots.

     MSAF Group's ability to compete against other lessors is determined, in
part, by (i) the composition of its fleet in terms of mix, relative age and
popularity of the aircraft types; (ii) operating restrictions imposed by the
Indenture, and (iii) the ability of other lessors, who may possess substantially
greater financial resources, to offer leases on more favorable terms than MSAF
Group.

     For the purposes of this report, the "SECOND QUARTER 1999" shall comprise
information from the three monthly cash reports dated March 15, 1999, April 15,
1999 and May 17, 1999. The financial data in these reports includes cash
receipts from February 10, 1999 (beginning of the Collection Period for the
March Report) up to May 11, 1999 (end of the Collection Period for the May
Report) and payments made by MSAF between February 10, 1999 and up to May 17,
1999 (the Note Payment Date for the May Report).

                                       29
<PAGE>   31

     Similarly, for the purposes of this report, the "PRIOR YEAR" period shall
comprise information from the monthly cash reports dated April 15, 1998 and May
15, 1998. The financial data in these reports includes cash receipts from March
3, 1998 (date of securitisation) up to May 11, 1998 (end of the Collection
Period for the May 1998 Report) and payments made by MSAF between March 3, 1998
and up to May 15, 1998 (the Note Payment Date for the May 1998 Report).

II. COMPARISON OF ACTUAL CASH FLOWS VERSUS PROSPECTUS FOR SECOND QUARTER 1999

     The February 20, 1998 Offering Memorandum (the "OFFERING MEMORANDUM") and
the November 4, 1998 Prospectus (the "PROSPECTUS") for the Notes contain
assumptions in respect of MSAF's future cash flows and cash expenses (the
"ASSUMPTIONS"). In the Second Quarter 1999, MSAF generated approximately $26.6
million in Net Cash Collections, lower than assumed in the Prospectus by $0.2
million. An analysis of the quarterly Cash Collections, Cash Expenses and Note
Payments is given in Sections A, B and C below.

SECTION A -- CASH COLLECTIONS

     CASH COLLECTIONS comprise lease rental payments, maintenance reserve
payments by lessees and cash interest paid on MSAF's cash balances. The
Prospectus assumed Cash Collections for the Second Quarter 1999, of $30.3
million. Total Cash Collections achieved in this period were $31.2 million, a
positive difference of $0.9 million. This difference is due to a combination of
the six factors set out below.

     1)  Gross lease rentals.  Cash Collections relating to gross lease rentals
for the Second Quarter 1999 amounted to $28.0 million or approximately $3.3
million less than the $31.3 million assumed in the period. This negative
variance is due to arrears ($1.8m), lower than assumed rentals following certain
re-leasing events ($1.0 million) and rentals lost due to non-revenue earning
aircraft ($0.5 million). Non-revenue earning aircraft are termed "Aircraft on
Ground" or "AOG's". For further details, see "Developments -- Lessee
Difficulties" below.

     2)  Other Cash Received.  Other Cash received for the Second Quarter 1999,
was approximately $0.04 million (late payments charges paid by lessees), a
positive variance of $0.04 million. The Prospectus makes no assumption as to
Other Cash Received.

     3)  Repossession and other stress related costs (net of security deposits
applied).  Repossession and other stress related costs (net of security deposits
applied) for the Second Quarter 1999 amounted to an inflow of $0.4 million,
compared to a cost of $1.4 million in assumed stress related costs for this
period. The inflow of $0.4 million relates to the return of security deposits
from two lessees, Onur Air and Guyana Airways, net of repossession and
redelivery costs incurred.

     4)  Net Lease rentals.  The Prospectus assumes a 4.5% reduction in gross
lease rentals due to certain stress related costs (repossession costs, AOG
expenses and Bad Debts) ("NET LEASE RENTALS"). For the Second Quarter 1999
assumed Net Lease Rentals were $30.0 million. Actual Net Lease Rentals for the
period were $28.5 million, $1.5 million less than the Assumptions principally
because of lower than assumed gross lease rentals, which were partially offset
by lower than assumed repossession and other stress related costs. In the
current leasing market, it is possible that net lease rentals will continue to
fall short of the Assumptions in the current financial year for reasons MSAF
Group has experienced already; lessee defaults, rentals not received due to
Aircraft On Ground, repossession costs and lease rental reductions. For further
details, see "Developments -- Lessee Difficulties" below.

     5)  Net Maintenance.  In the Second Quarter 1999 maintenance receipts were
$4.6 million, exceeding maintenance disbursements of $2.3 million by $2.3
million. The Prospectus assumes that maintenance receipts will equal maintenance
disbursements over the term of the Notes, and therefore, maintenance receipts
and maintenance disbursements are both assumed to be zero in each Note Payment
Period. In any particular Note Payment Period, however, there will be actual
maintenance receipts and disbursements and it is unlikely that maintenance
receipts will equal maintenance disbursements in any such period. It is likely
that maintenance

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disbursements will increase due to anticipated engine overhauls and re-leasing
expenses which MSAF Group originally expected to incur in 1998 but which MSAF
Group now expect to incur in the current year. As of May 17, 1999, there was
approximately $5.4 million held in the Expense Account for projected maintenance
and modification expenses over the following three months.

     6)  Interest received.  Actual interest received for the Second Quarter
1999 was $0.4 million compared to $0.3 million in the Prospectus. The difference
is due to a combination of two offsetting factors. First, actual interest
received includes interest received on amounts in the Expense Account and
interim balances in the Collection Account which are not included in the
Prospectus assumptions. Second and partially offsetting the impact of these cash
balances on which interest has been earned, the Prospectus assumed a
reinvestment rate of 5.75% while the average reinvestment rate for the period
was approximately 5.17%.

SECTION B -- CASH EXPENSES

     CASH EXPENSES consists of Cash Operating Expenses and Selling, General and
Administrative Expenses.

     CASH OPERATING EXPENSES includes all fees, costs or expenses paid by MSAF
Group in the course of the business activities permitted to be conducted by it
under the Indenture. The cash outflows in respect of Operating Expenses shown in
the Prospectus were assumed to be $1.1 million for the Second Quarter 1999.
Total cash expenses paid in this period were approximately $2.1 million, a
negative variance of $1.0 million. This variance is due to a combination of
factors set out below.

     1)  Insurance, re-leasing and other costs.  Insurance, re-leasing and other
costs incurred were approximately $0.3 million for the Second Quarter 1999,
which was $0.8 million less than the assumed costs of $1.1 million for the
period. Actual costs were in respect of Directors and Officers annual insurance
premium and the quarterly premium for contingent insurance coverage for the
portfolio. The Prospectus assumes these costs are 3% of gross lease revenues.

     2)  Increase in Accrued Expenses.  $1.8 million of accrued expenses was
transferred to the expense account in the Second Quarter 1999 and is expected to
be payable in the current year. The balance in the Expense Account on May 17,
1999 was $6.1 million. Approximately $5.4 million relates to accrued maintenance
expenses while the remaining $0.7 million relates to accrued insurance,
re-leasing and other costs. The Prospectus assumes there are no accrued
expenses.

     SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") include all fees paid
to the Aircraft Manager, Administration Agent, Independent Trustees and other
miscellaneous service providers. Total SG&A costs for the Second Quarter 1999
were approximately $2.5 million compared to $2.4 million assumed in the
Prospectus. This variance is due to a combination of the factors set out below.

     1)  Servicer fees.  Fees paid to ILFC, as Servicer, during the Second
Quarter 1999 amounted to $1.3 million, which is $0.3 million lower than the
assumed cost of $1.6 million for the period. As a significant portion of the
Servicer fees are calculated as a percent of rental revenue actually received
and gross rental revenue is lower than expected, the fee paid to ILFC is also
lower.

     2)  Other service provider fees and overhead.  Other service provider fees
and overhead amounted to $1.2 million for the Second Quarter 1999. This is $0.4
million more than the assumed amount of $0.8 million for the period, mainly due
to higher than assumed overhead costs paid in the period (associated with
registering the Notes with the SEC) which were partially offset by lower than
assumed Administrative Agent's fee because of actual lower rental revenues.

SECTION C -- NOTE PAYMENTS

     NOTE PAYMENTS consists of interest payments (net of swap effects), and
principal payments to Noteholders.

     Interest payments.  Actual interest payments to Noteholders net of swap
effects were $16.9 million, slightly lower than assumed net payments of $17.3
million for the Second Quarter 1999, reflecting faster than expected
amortisation of the A-2 Notes.
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<PAGE>   33

     Principal payments.  Total principal distributions in the Second Quarter,
1999 were $9.7 million, an excess of $0.2 million over assumed total debt
amortization for this period. The principal amortization payments were made with
respect to the A-2 and B-1 Notes.

III. COMPARISON OF SECOND QUARTER 1999 ACTUAL CASH FLOWS VERSUS PRIOR YEAR
     PERIOD

     In the Second Quarter 1999, MSAF Group generated approximately $26.6
million in Net Cash Collections, $2.7 million lower than assumed in the
Prospectus. An analysis of the quarterly Cash Collections, Cash Expenses and
Note Payments is given in Sections A, B and C below.

SECTION A -- CASH COLLECTIONS

     1)  Gross lease rentals.  Cash Collections relating to gross lease rentals
for the Second Quarter, 1999 were $28.0 million or approximately $0.1 million
less than in the Prior Year period. Gross lease rentals were essentially
unchanged in comparison to the Prior Year period.

     2)  Other Cash Received.  Other cash received in the Second Quarter, 1999
was approximately $0.04 million, compared to $0.2 million received in the Prior
Year period. Other Cash Received was essentially unchanged in comparison to the
Prior Year period.

     3)  Repossession and other stress related costs (net of security deposits
applied).  Repossession and other stress related costs (net of security deposits
applied) for the Second Quarter 1999 amounted to an inflow of $0.4 million
compared to an inflow of $0.3 million in the Prior Year period. Repossession and
other stress related costs were essentially unchanged in comparison to the Prior
Year period.

     4)  Net lease rentals.  Actual net lease rentals in the Second Quarter 1999
were $28.5 million, approximately the same as in the Prior Year period.

     5)  Net Maintenance.  In the Second Quarter 1999, maintenance receipts were
$4.6 million, exceeding maintenance disbursements of $2.3 million by $2.3
million. This compares to maintenance received of $3.1 million against
maintenance expenses paid of $1.1 million in the Prior Year period. While net
maintenance was higher in the Second Quarter 1999, significant maintenance
events are anticipated for the remainder of this financial year.

     6)  Interest received.  Actual interest received for the Second Quarter
1999 was $0.4 million compared to $0.7 million received in the Prior Year
period. The higher interest earned in the Prior Year period was due to cash held
on deposit in the Aircraft Purchase Account to fund the acquisition of two
aircraft that had not yet been delivered.

SECTION B -- CASH EXPENSES

     CASH EXPENSES consists of Cash Operating Expenses and Selling, General and
Administrative Expenses.

     CASH OPERATING EXPENSES includes all fees, costs or expenses paid by MSAF
Group in the course of the business activities permitted to be conducted by it
under the Indenture. Cash Operating Expenses paid in the Second Quarter 1999
were approximately $2.1 million, compared to $0.8 million in the same period in
1998. This variance is due to a combination of the factors set out below.

     1)  Insurance, re-leasing and other costs.  Insurance, re-leasing and other
costs incurred were approximately $0.3 million for the Second Quarter 1999,
which was $0.1 million lower than in the Prior Year period. This was mainly due
to the timing of payment of insurance premiums.

     2)  Increase in Accrued Expenses.  $1.9 million of accrued expenses were
transferred to the expense account in the current period. This compares to a
transfer of $0.4 million in the Prior Year period. The increase in Accrued
Expenses relates primarily to an increase in projected maintenance costs.

     SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (SG&A) include all fees paid
to the Aircraft Manager, Administration Agent, Independent Trustees and other
miscellaneous service providers. Total SG&A costs for
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<PAGE>   34

the Second Quarter 1999 were approximately $2.5 million compared to $1.1 million
in the Prior Year period. This difference is due to a combination of the factors
set out below.

     1)  Servicer fees.  Fees paid to ILFC, as Servicer, during the Second
Quarter 1999 were $1.3 million, an increase of $0.5 million over the Prior Year
period. In 1998, the $3.0 million fixed fee was paid to ILFC as an upfront fee
of $2.0 million in December 1997 and a further $1.0 million was paid in even
installments every month. In 1999, the entire base fee of $3.0 million is being
paid in installments, hence the higher monthly charge in the current year.

     2)  Other Service Providers and Overhead.  The total expenses for Other
Service Providers and Overhead was $1.2 million for the Second Quarter 1999,
versus $0.3 million for the Prior Year period, a variance of $0.9 million. $0.6
million of this difference can be attributed to an increase in Overhead costs,
which increased from less than $0.1 million in Prior Year period to $0.7 million
in the Second Quarter 1999. The increase in Overhead costs was primarily related
to costs associated with the registration of the Notes with the SEC. The
remaining $0.3 million variance relates to an increase in the fee paid to the
Administrative Agent. The fee calculation for the Administrative Agent in the
Prior Year period did not include accrued rentals and was therefore lower.

SECTION C -- NOTE PAYMENTS

     NOTE PAYMENTS consist of interest payments (net of swap effects), and
principal payments to Noteholders.

     Interest payments.  Actual interest payments to Noteholders, net of swap
effects, were $16.9 million in the Second Quarter 1999, compared to $14.4
million in the Prior Year period.

     Principal Payments.  Total Principal distributions were $9.7 million in the
Second Quarter 1999, compared to $14.9 million in the Prior Year period. The
higher distribution in the Prior Year period was as a result of $2.7 million in
higher Net Cash Collections and the $2.5 million lower interest costs.

IV. OTHER FINANCIAL DATA

     CASH

     Cash held at May 17, 1999 was $31.1 million. Of this amount, $25 million
represents the cash portion of the Liquidity Reserve Amount (which is used as a
source of liquidity for, among other things, maintenance obligations, security
deposit return obligations, cash operating expenses and contingent liabilities)
and $6.1 million represents accrued expenses and is held in the Expense Account
to cover maintenance and re-leasing expenses expected to fall due in the next
quarter.

     In addition to the $31.1 million cash portion at May 17, 1999, the
Liquidity Reserve Amount also contained $41.1 million of undrawn credit and
liquidity facilities from Morgan Stanley Dean Witter & Co. and ILFC.

     AIRCRAFT VALUES

     Under the terms of the Notes, MSAF Group is obliged to obtain annual
appraisals of the Base Value of each aircraft from three independent appraisers
by October 31 of each year. Generally, where the appraisals indicate a Base
Value decline significantly in excess of the value decline assumed under the
terms of the Notes, excess cash flow is redirected to the extent required to the
Class A Notes via the Class A Scheduled Principal Payment Amount. The most
recent appraisals occurred in September 30, 1998 and the next are due to occur
no later than October 31, 1999. The actual appraised value of the fleet as at
September 30, 1998 was $1,029.4 million versus an assumed value of $1,058.3
million as at November 17, 1998. As the decline in value was within the limits
permitted by the Indenture, there was no requirement to redirect cash flow to
the Class A Notes.

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     A-D NOTE BALANCE

     As of May 17, 1999, the aggregate amount of Class A-D Notes outstanding was
$958.9 million, approximately $12.9 million lower than assumed due to higher
than assumed principal repayments with respect to the Class A-2 Notes.

V. LESSEE DEVELOPMENTS

     As of July 1, 1999, three current lessees were in arrears. The aircraft on
lease to the three lessees in arrears represent approximately 11.1% of the
appraised value of the portfolio at September 30, 1998 and all three lessees are
based in Brazil. The amounts outstanding and overdue for the three lessees in
respect of rental payments, maintenance reserves and other miscellaneous amounts
due under the leases (net of default interest and certain cash in transit)
amounted to approximately $8.6 million. The weighted average number of days past
due of such arrears was 105 days. For further details, see "Latin America"
below.

     In addition, as of July 1, 1999 an aggregate of $2.2 million was owed to
MSAF Group from two of its former lessees. In both cases, MSAF Group has leased
the aircraft to other carriers.

     EUROPE & MIDDLE EAST EMERGING

     Following the termination of a lease with Onur Air, the related aircraft
(an A321-100) was placed with another Turkish charter airline, Air Alfa. Rental
payments and maintenance reserves outstanding under the old lease amounted to
approximately $2.0 million. The aircraft was non-revenue earning for a period
and the cost of downtime between leases was $0.2 million. However, Onur Air has
commenced payment of restructured amounts in accordance with a termination
agreement. Amounts in arrears are scheduled for repayment by October 1999. The
aircraft represents 4.3% of the appraised value of the portfolio at September
30, 1998.

     ASIA

     Asia has been severally affected by economic and financial difficulties,
although limited signs of recovery were exhibited during the last quarter.
Currently, MSAF Group leases 13.0% of its fleet in the Asia Region (5.5% in
South Korea, 4.9% in Taiwan and 2.6% in China) and 6.7% in Pacific and Other
regions (6.7% in Fiji) by appraised value of the portfolio at September 30,
1998. As of July 1, 1999 none of these lessees were in arrears although severe
financial difficulties have been reported for certain other air carriers in the
region. One lessee restructured its lease such that rental payments will be
lower over an extended lease term.

     LATIN AMERICA

     Considerable economic uncertainty continues to affect the major economies
in Latin America. The devaluation of the Brazilian currency in January 1999
continued to adversely impact the major carriers whose lease obligations were
predominantly in U.S. dollars.

     As of July 1, 1999, VARIG had decided to terminate the lease of a B747-300
aircraft and is currently negotiating a termination agreement with ILFC. The
termination agreement will cover repayment of rental and maintenance arrears
owed to date, and certain repossession and redelivery expenses. In the interim,
VARIG have agreed to park and insure the aircraft, at their cost. This lease had
a security deposit of $1.0 million, which has been drawn down by MSAF Group.

     As a large-widebody geared to the Asian market, the B747-300 aircraft is
one of the aircraft types that is least popular at present with 11 available for
lease and 8 currently in storage, according to Airclaims. There can be no
assurance that ILFC will procure a new lease with terms similar to those of the
terminated lease with VARIG. As of July 1, 1999, the total amount outstanding
for this lessee in respect of rental payments and maintenance reserves under
this lease amounted to approximately $4.8 million. The aircraft represents 6.1%
of the appraised value of the portfolio at September 30, 1998.

     Another Brazilian lessee, Passeredo, representing 2.1% of the appraised
value of the portfolio at September 30, 1998, has been operating one A310-300
subject to a finance lease and has not made lease payments since September 1998.
After protracted negotiations with ILFC, the lessee has agreed to a

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<PAGE>   36

repayment schedule, which provides for payment of part of the arrears. As of
July 1, 1999, total amount outstanding for this lessee in respect of rental
payments amounted to approximately $3.3 million.

     The rental arrears of the third Brazilian lessee, which accounts for 2.9%
of the appraised value of the portfolio at September 30, 1998, have been
restructured and the lessee is in arrears with respect to the restructured
amounts. As of July 1, 1999, total amount outstanding for this lessee in respect
of rental payments amounted to $0.5 million.

     MSAF Group currently leases 17.4% of its fleet in Latin America (6.3% in
Mexico and 11.1% in Brazil) by appraised value of the portfolio at September 30,
1998.

     OTHER

     The lease with Guyana Airways was terminated by agreement on April 2, 1999
with rental arrears due of $1.3 million. MSAF Group is likely to incur costs of
approximately $2.9 million in the redelivery of this aircraft. This cost takes
into account a $3.0 million lump sum termination payment paid by Guyana and the
drawdown of the security deposit of $0.7 million but excludes $0.7 million of
maintenance reserves received by MSAF Group from Guyana over the lease term.
MSAF Group has filed an insurance claim in respect of certain maintenance costs
it has incurred to date. The Guyana aircraft is a B757-200ER and accounts for
3.3% of the appraised value of the portfolio at September 30, 1998. The aircraft
was re-leased to National Airlines, a U.S. carrier in June 1999.

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