<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 PERIOD ENDED OCTOBER 31, 1998

                                       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

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

                          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 [ ]                                             No [X]

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 of Common Stock               October 31, 1998
------                                     ---------------------               ----------------
<S>                                               <C>                               <C>
Morgan Stanley Aircraft Finance                     N/A                               N/A
</TABLE>




<PAGE>   2




                         MORGAN STANLEY AIRCRAFT FINANCE

                 FORM 10-Q FOR THE PERIOD ENDED OCTOBER 31, 1998

                                      INDEX

<TABLE>
<CAPTION>
                                                                                   PAGE NO.
                                                                                   --------
<S>                                                                                <C>
PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS (UNAUDITED)

-   Interim Condensed Consolidated Financial Statements (Unaudited)
-   Notes to the Interim Condensed Consolidated Financial Statements (Unaudited)

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

PART II. OTHER INFORMATION

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

SIGNATURES

INDEX TO EXHIBITS
</TABLE>



                                       2
<PAGE>   3
PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

 
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
 
                  INTERIM CONDENSED CONSOLIDATED BALANCE SHEET
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                              OCTOBER 31,
                                                                 1998
                                                              -----------
                                                              (UNAUDITED)
<S>                                                           <C>
                                 ASSETS
Cash and cash equivalents...................................  $   38,122
Receivables:
  Lease income, net.........................................       2,491
  Investment income and other...............................         156
Aircraft under operating leases, net........................     937,231
Investment in capital lease, net............................      20,777
Underwriting and other issuance related costs, net of
  amortisation..............................................      17,145
                                                              ----------
Total Assets................................................  $1,015,922
                                                              ==========
           LIABILITIES AND BENEFICIAL INTERESTHOLDER'S DEFICIT
Payables:
  To Morgan Stanley Financing Inc...........................  $        1
  Interest payable to Noteholders...........................       2,599
Deferred rental income......................................       8,658
Provision for maintenance...................................      52,423
Other liabilities...........................................      15,671
Notes payable:
  Class A-1.................................................     400,000
  Class A-2.................................................     278,802
  Class B-1.................................................      95,127
  Class C-1.................................................     100,000
  Class D-1.................................................     110,000
                                                              ----------
                                                               1,063,281
                                                              ----------
Commitments and contingencies
Beneficial Interestholder's Deficit:
  Beneficial Interest.......................................           1
  Deemed Distribution.......................................     (15,305)
  Accumulated Deficit.......................................     (32,055)
                                                              ----------
  Total Beneficial Interestholder's Deficit.................     (47,359)
                                                              ----------
Total Liabilities and Beneficial Interestholder's Deficit...  $1,015,922
                                                              ==========
</TABLE>
 
  See Notes to Interim Condensed Consolidated Financial Statements (Unaudited)

                                      3
 
<PAGE>   4
 
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
 
               INTERIM CONDENSED CONSOLIDATED STATEMENT OF INCOME
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                              ELEVEN MONTHS ENDED
                                                               OCTOBER 31, 1998
                                                              -------------------
                                                                (UNAUDITED)
<S>                                                           <C>
Revenues:
  Lease income, net.........................................       $109,142
  Investment income on collection account...................          1,993
                                                                   --------
  Total revenues............................................        111,135
                                                                   --------
Expenses:
  Interest expense..........................................         44,948
  Depreciation expense......................................         34,756
  Operating expenses:
     Fees payable...........................................          8,483
     Maintenance and other aircraft related costs...........          3,309
                                                                   --------
  Total expenses............................................         91,496
                                                                   --------
Net income..................................................       $ 19,639
                                                                   ========
</TABLE>
 
  See Notes to Interim Condensed Consolidated Financial Statements (Unaudited)

                                       4
<PAGE>   5
 
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
 
             INTERIM CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                              ELEVEN MONTHS ENDED
                                                               OCTOBER 31, 1998
                                                              -------------------
                                                                  (UNAUDITED)
<S>                                                           <C>
Cash flows from operating activities
  Net income................................................      $    19,639
  Adjustments to reconcile net income to net cash provided
     by operating activities:
  Depreciation expense--equipment under operating leases....           34,756
  Amortisation of underwriting and other issuance related
     costs..................................................              745
  Changes in assets and liabilities:
     Receivables:
       Investment income and other..........................             (156)
       Lease income.........................................           (2,354)
     Investment in capital lease............................            4,224
     Provision for maintenance..............................           13,688
     Interest payable to Noteholders........................            2,599
     Deferred rental income.................................            8,658
     Other liabilities......................................              366
                                                                  -----------
Net cash provided by operating activities...................           82,165
                                                                  -----------
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 underwriting costs............        1,041,610
  Proceeds from borrowings from Morgan Stanley Financing
     Inc....................................................          853,490
  Beneficial Interest Distribution..........................         (976,257)
  Repayments of Notes.......................................          (66,071)
  Other issuance related costs..............................           (9,500)
                                                                  -----------
Net cash provided by financing activities...................          843,272
                                                                  -----------
Net increase in cash and cash equivalents...................           38,122
Cash and cash equivalents at beginning of period............               --
                                                                  -----------
Cash and cash equivalents at end of period..................      $    38,122
                                                                  ===========
</TABLE>
 
  See Notes to Interim Condensed Consolidated Financial Statements (Unaudited)

                                       5
<PAGE>   6
 
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
 
       INTERIM CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN BENEFICIAL
                               INTEREST/(DEFICIT)
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                          RETAINED
                                                                          EARNINGS             TOTAL
                                          BENEFICIAL       DEEMED       (ACCUMULATED    BENEFICIAL INTEREST
                                           INTEREST     DISTRIBUTION      DEFICIT)           (DEFICIT)
                                          ----------    ------------    ------------    -------------------
                                                                            (UNAUDITED)
<S>                                       <C>           <C>             <C>             <C>
Issuance of Beneficial Interest.......     $      1       $     --        $     --           $       1
Net income............................           --             --           4,704               4,704
                                           --------       --------        --------           ---------
Balance at November 30, 1997..........            1             --           4,704               4,705
Net income............................           --             --          19,639              19,639
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 October 31, 1998...........     $      1        (15,305)       $(32,055)          $ (47,359)
                                           ========       ========        ========           =========
</TABLE>
 
  See Notes to Interim Condensed Consolidated Financial Statements (Unaudited)

                                       6
<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, leasing, selling and maintaining
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's obligations, including its financial
debt obligations, are not obligations of, or guaranteed by, MSDW, MSF or any
person other than MSAF.
 
     The 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 condensed consolidated financial statements are prudent and reasonable.
Actual results could differ materially from these estimates.
 
     All material intercompany transactions have been eliminated.
 
     The condensed consolidated financial statements should be read in
conjunction with MSAF Group's consolidated financial statements and notes
thereto as of and for the period ended November 30, 1997. The 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.
 
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 October 31, 1998
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 capitalised airlines are more likely to
seek operating leases. In addition, at October 31, 1998, 15 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 recently 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 of
deposits. MSAF Group will continue to manage its exposure to particular
countries, regions and lessees through concentration limits. At October 31,
1998, MSAF Group had recorded allowances for doubtful debts against lease income
receivables for four lessees.

 
                                       7
<PAGE>   8
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
 
NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) --
                                  (CONTINUED)
 
NOTE 3 -- AIRCRAFT
 
<TABLE>
<CAPTION>
                                                                   OCTOBER 31, 1998
                                                                (DOLLARS IN THOUSANDS)
                                                                ----------------------
<S>                                                             <C>
Stage 3 Aircraft and one spare engine:
Cost........................................................           $972,030
Less Accumulated depreciation...............................            (34,799)
                                                                       --------
                                                                       $937,231
                                                                       ========
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........................................                  8
From one to five years......................................                 20
Less than one year..........................................                  5
                                                                       --------
Total aircraft portfolio (including one spare engine).......                 33
                                                                       ========
</TABLE>

     At October 31, 1998, there were no non-revenue earning aircraft in MSAF
Group's portfolio.
 
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>
                                                                   OCTOBER 31, 1998
                                                                (DOLLARS IN THOUSANDS)
                                                                ----------------------
<S>                                                             <C>
Minimum lease payments receivable...........................           $25,642
Less: Unearned income.......................................            (4,865)
                                                                       -------
Net investment in capital lease.............................           $20,777
                                                                       =======
</TABLE>

     At October 31, 1998, minimum lease payments for each of the five succeeding
years are $4 million.
 
     Unearned income is recognized over the term of the lease using the interest
method.
 
NOTE 5 -- NOTES PAYABLE
 
     During the eleven month period ended October 31, 1998, MSAF Group acquired
29 aircraft and one spare engine having an aggregate cost of $926 million. MSAF
Group financed these purchases primarily through additional 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 amortised over the expected
life of the Notes, which is currently estimated to be 16 years.
 
                                       8
<PAGE>   9
                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 14, 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 is obligated to use its best efforts to consummate an exchange
offer (the "Exchange Offer") pursuant to which the Notes would be exchanged for
substantially similar securities issued pursuant to an effective registration
statement under the Securities Act of 1933. If the Exchange Offer was not
consummated or a shelf registration statement was not declared effective on or
prior to November 30, 1998, thereafter an additional incremental interest amount
accrues on each subclass of Notes, at an annual rate of 0.50%. Such additional
incremental interest on the Notes has accrued since December 1, 1998 and will be
payable until the date that the Exchange Offer is consummated or until such time
as MSAF Group causes a shelf registration statement with respect to resales of
the Notes to become effective.
 
     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 and available for
distribution are paid in accordance with the priorities specified in the Note
Indenture.
 
NOTE 6 -- LINES OF CREDIT
 
     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 lines 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 "MSF Facility")
between MSF and MSAF Group, MSF has agreed to extend loans in a maximum amount
of $10 million.
 
     As of October 31, 1998, the aggregate amount available under the ILFC
Facility and the MSF Facility was approximately $41.0 million.
 
                                       9
<PAGE>   10
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
 
NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) --
                                  (CONTINUED)
 
NOTE 7 -- DERIVATIVE FINANCIAL INSTRUMENTS
 
     The leasing revenues of MSAF Group will be 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 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 counter party, 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 payment 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 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
liablity within other liabilities in its Condensed Consolidated Balance Sheet,
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 received
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 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 October 31, 1998 was $(32) 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 basis with changes in fair value reflected in
interest expense. At October 31, 1998, the fair value of these swaps was $(7.6)
million.

     The gross notional amounts of these swaps are indicative of MSAF Groups'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

                                       10
<PAGE>   11
                MORGAN STANLEY AIRCRAFT FINANCE AND SUBSIDIARIES
 
NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) --
                                  (CONTINUED)
 

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 8 -- 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 eleven
month period ended October 31, 1998, Cabot Aircraft Services Limited received a
fee of $1.0 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 $.03 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 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 (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 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, 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 three trustees
are unaffiliated with MSDW.
 
NOTE 9 -- COMMITMENTS
 
     MSAF Group did not have any material contractual commitments for capital
expenditures at June 30, 1998.
 
     In accordance with the terms of a servicing agreement (the "Servicing
Agreement"), ILFC 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 Servicing Agreement, fees payable to ILFC by MSAF Group are
calculated as a percentage of the lease rentals received, in addition to certain
incentive-based fees.
 
     The Servicing Agreement expires in 2023, although each party has the right
to terminate the Servicing Agreement under certain circumstances.
 
                                       11
<PAGE>   12
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 the Initial
Aircraft and the placement of certain initial 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.
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
the Servicer, Administrative Agent, Cash Manager, Financial Advisor, Trustee and
other service providers, and payments to Swap Providers. Upon the issuance of
the Notes, MSAF will have no indebtedness other than the Notes.
 
     MSAF Group's ability to generate sufficient cash from its Initial 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 Initial 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
Initial Aircraft age, and on any unforeseen contingent liabilities arising.
There can be no assurance that cash flows generated from the Initial Aircraft
assets will be sufficient to service interest and principal on the Notes.
 
     MSAF Group will not use operational cash flow to pay the purchase price for
Additional Aircraft but, instead, will issue Additional Notes to fund such
purchase price. Any such Additional Notes will be issued in compliance with the
limitations set forth in MSAF's Indenture.
 
RECENT DEVELOPMENTS
 
     INITIAL AIRCRAFT
 
     As of May 31, 1998, all but one of the Contract Aircraft were acquired by
MSAF. The undelivered aircraft is a B737-400 on lease to the Turkish national
carrier, THY, with an appraised value of $28.82 million. Pursuant to the
Indenture, the Trustees decided not to substitute this aircraft but instead
distributed to Noteholders that portion of the proceeds from the Offering of the
Old Notes relating to this aircraft on June 15, 1998 pursuant to the priority of
payments set forth in the Indenture. As a result, the overall size of the
Initial Aircraft is 32 aircraft plus a spare engine with revised total Initial
Appraised Value reduced to $1,086.69 million. No aircraft have been sold or
suffered a total loss since March 3, 1998. As of October 31, 1998, the Initial
Aircraft were subject to leases with 29 lessees in 19 countries.

     In the period from March 3, 1998 to October 31, 1998, four of the Initial
Aircraft were aircraft on ground ("AOG") for a period of 36, 42, 59 days and 10
days, respectively. Part of the AOG period was dedicated to performing
maintenance work on the aircraft prior to releasing. As of October 31, 1998
three of the Initial Aircraft that were previously AOG were subject to signed
lease agreements with new lessees. A letter of intent was entered into with
Flying Colours to re-lease the remaining AOG which was returned early by
Transaero on October 22, 1998.

     APPRAISED VALUES AT SEPTEMBER 30, 1998

     The most recent annual appraisals of the Base Value of each aircraft
occurred on September 30, 1998 with total appraised value of the Initial
Aircraft at September 30, 1998 equal to $1,029.44 million. The appraisals at
September 30, 1998 did not indicate a Base Value decline sufficiently in excess
of the value decline assumed under the terms of the Notes to require excess cash
flows to be redirected to the Class A Notes via the Class A Scheduled Principal
Payment Amount.
 
                                       12
<PAGE>   13
 
     LESSEE DIFFICULTIES
 

     Since March 3, 1998, in addition to the Lessee difficulties that resulted
in the repossession of three aircraft and the early return of a fourth aircraft
as discussed below under "Results of Operations -- Eleven Months Ended October
31, 1998 -- Operating Lease Income", there have been difficulties with respect
to one Lessee in the Europe/Middle East region, representing approximately 4.3%
of the adjusted appraised value of the portfolio as of August 31, 1998. With
respect to this Lessee, lease rentals and maintenance reserves were restructured
in March 1998 and at August 31, 1998 the lessee was in arrears with respect to
the restructured payment amounts. Such arrears amounted to $38,171 at August 31,
1998 and other amounts in arrears totalled approximately $896,115 at August 31,
1998. Another lessee has been publicly reported to be having liquidity
difficulties stemming from both withdrawal of state aid and strikes, although it
was not in arrears as of August 31, 1998.
 
     B737 INSPECTIONS
 
     On May 14, 1998, the Federal Aviation Administration (FAA) issued a
directive requiring B737s with between 30,000 and 40,000 hours of flying time to
be inspected within 45 days for chafed wiring in conduits that run through the
plane's fuel tank that could cause a fire or explosion. MSAF owns 10 B737-
300/400/500s. All these aircraft have below 30,000 flight hours and will not be
inspected under the current directive. MSAF does not believe the cost to comply
with this directive in the future will be significant.
 
     B747 INSPECTIONS
 
     On May 25, 1998, Boeing issued a Service Bulletin recommending inspection
of all B747 center fuel tanks to check wiring and grounding straps, pumps, fuel
lines and fittings and other equipment and installation of a "flame arrestor"
for a scavenge pump. MSAF owns one B747-300 on lease to VARIG and does not
believe the cost to comply with this Service Bulletin will be significant.
 
     ECONOMIC CRISES IN EMERGING MARKETS
 
     Emerging market economies have recently been affected by severe economic
and financial difficulties. The economic crisis in Asia has spread to Russia and
to Latin America as well. As of August 31, 1998 MSAF leased 43.31% of its fleet
in emerging markets, including 12.75% of its fleet in "emerging" European
markets, 12.89% in "emerging" Asian markets and 17.67% in Latin America (using
MSCI designations).

     As of August 31, 1998, MSAF leased 12.89% of its fleet in Asia (5.3% in
South Korea, 5.0% in Taiwan and 2.6% in China) and 6.6% in Pacific and Other
regions (6.6% in Fiji) by assumed appraised value as of June 30, 1998. As of
August 31, 1998, none of these lessees were in arrears although severe financial
difficulties have been reported for certain other air carriers in the region.

     The recent economic crisis in Russia continues to threaten that region.
Transaero, MSAF's only lessee in Russia, recently returned its aircraft to MSAF
on October 22, 1998.

     As of August 31, 1998 MSAF leased 17.67% of its fleet in Latin America
(11.36% in Brazil and 6.31% in Mexico). None of the MSAF Group Lessees in Latin
America were in arrears as of August 31, 1998.

RESULTS OF OPERATIONS -- ELEVEN MONTHS ENDED OCTOBER 31, 1998
 
     LEASE INCOME
 
     Lease income for the eleven month period from December 1, 1997 to October
31, 1998 amounted to $109.1 million. Many of the Initial Aircraft were not owned
by MSAF for all of the period. During the period, there was a loss in lease
rental revenues caused by three AOG ($2.0 million) and the early return of one
aircraft on lease to Transaero. Three aircraft had been repossessed from Western
Pacific Airlines and Pan Am Airlines (formerly Carnival) but were all subject to
signed lease agreements as of October 31, 1998. The three aircraft were placed
on lease with Olympic Airways, the Greek national carrier, VASP, and TAESA. The
other aircraft which remains AOG is subject to a letter of intent with Flying
Colours. Part of the AOG period
 
                                       13
<PAGE>   14
 
was spent performing maintenance work on all three aircraft prior to re-leasing.
MSAF Group records the cash prepayments made by lessees for maintenance as a
component of the provision for maintenance liability account which appears on
the consolidated balance sheet. When the lessee incurs a maintenance
expenditure, 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 provision for maintenance liability 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.
 
     INVESTMENT INCOME
 
     In the eleven months ended October 31, 1998, MSAF earned interest income of
$2.0 million. Investment income is expected to decline going forward principally
because cash in the Aircraft Purchase Account has now been used to acquire the
Initial Aircraft except for a balance of $26.1 million which has been refunded
to investors in respect of the undelivered THY aircraft.
 
     INTEREST EXPENSE
 
     Interest expense, including swap costs, amounted to $44.9 million in the
eleven months ended October 31, 1998. Interest expense relates to the cost of
the Old Notes which were issued on March 3, 1998 and, therefore, only
outstanding for approximately eight months in the period. The weighted average
interest rate on the Subclass A-1 to D-1 Notes during the period from March 3,
1998 to October 31, 1998 was 5.41% and the average debt in respect of the
Subclass A-1 to D-1 Notes outstanding during the period since March 3, 1998 was
$1,034.0 million.

     MSAF is a party to eight interest rate swaps with Morgan Stanley Capital
Services Inc. ("MSCS"), a wholly-owned subsidiary of Morgan Stanley. In six of
these swaps, MSAF 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 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 counter party, on November 12, 1997 and February 19, 1998,
respectively. On March 3, 1998, all eight swaps were assigned to MSAF 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 in connection with the
assumption of these swap positions. MSAF 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 Sheet, 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 will pay fixed and received 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 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 remaining four swaps assumed by MSAF have an aggregate gross notional
principal amount of $400 million. Under these swap arrangements, MSAF will
pay/receive fixed and receive/pay floating amounts on a monthly basis. MSAF
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.
 
                                       14
<PAGE>   15
 
     DEPRECIATION
 
     The charge for depreciation in the eleven months ended October 31, 1998
amounted to $34.8 million. The charge is expected to be proportionately higher
in future periods given that MSAF did not own all of the Initial Aircraft
throughout the period from December 1, 1997 to October 31, 1998.
 
     OPERATING EXPENSES
 
     Service Provider Fees.  Service provider fees and expenses for the period
ended October 31, 1998 were $8.5 million. The most significant element was the
aircraft servicing fee paid to ILFC, which amounted to $5.2 million for the
period. A significant portion of the fees payable to ILFC are calculated as a
percent of rental revenue actually received. Accordingly, the fees paid to ILFC
reflected the lower rental revenue caused by AOGs and undelivered aircraft
during the period. MSAF's service provider expenses also included $1.1 million
in respect of administrative agency and cash management fees.
 
     Maintenance and Other Aircraft Related Costs.  Maintenance and other
aircraft related costs in the eleven months ended October 31, 1998 amounted to
$3.3 million. These costs reflected additional maintenance work that was
performed on the three aircraft which were repossessed. This work included a
"C-check" for certain of the aircraft and the installation of new landing gear.
In the next six months it is likely that maintenance disbursements will increase
proportionately due to anticipated engine overhauls and the larger number of
aircraft owned by MSAF.

     Insurance, re-leasing and other costs incurred in the eleven months ended
October 31, 1998 were approximately $0.7 million. It is expected that re-leasing
costs will increase proportionately over the next several months due to certain
aircraft modification payments expected to be reimbursed to lessees and costs
relating to reconfiguring aircraft for new lessees upon redelivery, including
the AOG that is subject to a letter of intent with Flying Colours. It is also
expected that additional insurance premiums relating to AOG will become payable
in the remainder of 1998.
 
     NET INCOME
 
     Net income for the eleven month period ended October 31, 1998 was $19.6
million.
 
     MSAF is a Delaware business trust treated as a branch of MS Financing Inc.
for U.S. Federal, state and local income tax purposes. As such, MSAF is not
subject to U.S. Federal, state and local income taxes.
 
FINANCIAL RESOURCES AND LIQUIDITY
 
     LIQUIDITY

     The cash balances at October 31, 1998 were $38.1 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 $13.1 million represents rental and maintenance
receipts.

     In addition to the $25 million cash portion at October 31, 1998, the
Liquidity Reserve Amount also contained $41.0 million of undrawn credit and
liquidity facilities from Morgan Stanley and ILFC. As of October 31, 1998,
ILFC's short term unsecured debt was rated A-1+ by Standard & Poor's, and,
accordingly, the letter of credit previously issued by the Bank of Montreal to
support ILFC's obligations under the ILFC Facility was canceled.
 
     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 cost of the
Notes, the efficacy of MSAF Group's interest rate hedging policies, the ability
of MSAF Group's swap providers to perform under the terms of their swap and
similar
                                       
                                       15
<PAGE>   16
 
obligations and whether MSAF Group will be able to refinance certain subclasses
of Notes that have not been repaid with lease cash flows.

     Net cash provided by operating activities in the eleven months ended
October 31, 1998 amounted to $82.2 million, principally reflecting non-cash
depreciation expense of approximately $34.8 million, net income of approximately
$19.6 million, provisions for maintenance of approximately $13.7 million and
deferral of recognition of advance rental payments of $8.7 million.
 
     CASH FLOWS FROM INVESTING AND FINANCING ACTIVITIES

     In the eleven months ended October 31, 1998, the use of cash flows from
investing activities was to acquire the Initial Aircraft. Cash flows from
financing activities in the eleven months ended October 31, 1998 primarily
reflect the proceeds from the Offering of the Old Notes and the payment to
Morgan Stanley Financing Inc., of a distribution with respect to the Beneficial
Interest.
 
     INDEBTEDNESS
 
General

     MSAF Group's indebtedness primarily consisted of the Subclass A-1 to D-1
Notes in the amount of $983.9 million at October 31, 1998.
 
Aircraft Values

     At September 30, 1997, the total appraised value of the 33 aircraft and the
spare engine that MSAF originally agreed to acquire from ILFC was $1,115.5
million. At September 30, 1998, the total appraised value of MSAF Group's 32
aircraft and spare engine (giving effect to the non-delivery of the THY
aircraft) was $1,029.4 million.

     Under the terms of the Notes, MSAF 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 on September 30, 1998 and the next are due to occur no later
than October 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 in the Collection Account and with
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, A-1+ by Standard & Poor's, or D-1+ by
DCR or is otherwise designated as an Eligible Provider by the Controlling
Trustees. Both the ILFC Facility discussed below under "-- ILFC Facility" and
the Morgan Stanley Facility discussed below under "-- Morgan Stanley 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 $66.0 million on October 31,
1998. The Minimum Liquidity Reserve Amount was approximately $15 million on
October 31, 1998. 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
 
                                       16
<PAGE>   17
 
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 such Rating Agencies of their respective ratings
of any MSAF Notes.
 
     If the balance of cash on deposit in the Collection Account, 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, which rank prior to, or pari passu 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 funds in the Collection Account, 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. However, the
balance of funds in the Collection Account, 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,
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.
 
     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 eleventh level in the priority of payments,
before the Second Collection Account Top-Up (any such facility, a "SECONDARY
ELIGIBLE CREDIT FACILITY").

     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 Initial Aircraft, 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 ADs, 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 Initial Aircraft as custodian for the benefit of the MSAF Group.
ILFC will hold all cash security deposits paid with respect to the Initial
Aircraft 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 Initial Aircraft and paid
by a single Lessee. Any interest accruing on amounts of Initial 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 which
MSAF 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.
ILFC's obligation to make such amounts available shall be limited to the "ILFC
FACILITY COMMITMENT" which was approximately $31.0 million on October 31, 1998.
The ILFC Facility Commitment
 
                                       17
<PAGE>   18
 
shall be equal to (i) at any time before a Facility Reduction Event, the sum of
(A) $10 million plus (B) total Initial Aircraft security deposits held by ILFC
for the benefit of MSAF at such time minus (C) all drawings previously made by
MSAF under the ILFC Facility ("ILFC FACILITY DRAWN AMOUNTS") 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. A "FACILITY REDUCTION
EVENT" means a termination of the Servicing Agreement prior to the twenty-fifth
anniversary of the date on which the last Initial Aircraft is delivered to MSAF
Group for a reason other than a sale of all the Initial Aircraft or the
repayment or defeasance of MSAF's debt.
 
     The ILFC Facility is a Secondary Eligible Credit Facility and, accordingly,
on the Payment Date following any drawing on the ILFC Facility, MSAF will be
obligated, to the extent there are Available Collections remaining after payment
of the Minimum Principal Payment Amount on the Class D Notes, 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) the twenty-fifth anniversary of the date on which the last Initial
Aircraft is delivered to MSAF Group, (ii) a sale of all the Initial Aircraft,
and (iii) the repayment or defeasance of all MSAF's debt.
 
     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 provided by an Eligible Provider at ILFC's expense (a "BACK-UP
FACILITY").
 
     MSAF 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 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 will hold the drawing proceeds
in the Collection Account 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 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 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. MSAF 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.
 
     MORGAN STANLEY FACILITY
 
     Under the Morgan Stanley Facility, Morgan Stanley will make loans to MSAF
which MSAF 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. Morgan Stanley's obligation to make such amounts available shall be
limited to the "MORGAN STANLEY FACILITY COMMITMENT". The Morgan Stanley Facility
Commitment, at any time, shall be equal to the sum of (A) $10 million minus (B)
all drawings previously made by MSAF under the Morgan Stanley Facility ("MORGAN
STANLEY FACILITY DRAWN AMOUNTS") and not repaid at such time.
 
                                       18
<PAGE>   19
 
     The Morgan Stanley Facility is a Secondary Eligible Credit Facility and,
accordingly, on the Payment Date following any drawing on the Morgan Stanley
Facility, MSAF will be obligated, to the extent that there are Available
Collections remaining after payment of the Minimum Principal Payment Amount on
the Class D Notes, to repay Morgan Stanley Facility Drawn Amounts to Morgan
Stanley, 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.
 
     Morgan Stanley's agreement to provide the Morgan Stanley Facility will
expire on the earlier of (i) a sale of all the Aircraft and (ii) the repayment
or defeasance of all MSAF's debt. Morgan Stanley has been designated by the
Controlling Trustees as an Eligible Provider. As of October 31, 1998, Morgan
Stanley's long-term unsecured debt was rated A1 by Moody's, A+ by Standard &
Poor's and AA- by DCR.
 
     OTHER FACILITIES
 
     There are currently no Primary Eligible Credit Facilities in place. MSAF
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 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 eleventh level in the order of priorities,
before the Second Collection Account Top-Up.

INTEREST RATE MANAGEMENT

     The leasing revenues of MSAF Group will be 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 is a party to
eight interest rate swaps (the "INITIAL SWAPS") with MSCS, a wholly-owned
subsidiary of Morgan Stanley. In six of these swaps MSAF pays a fixed monthly
coupon and receives one month LIBOR and in two of these swaps MSAF pays one
month LIBOR and receives a fixed monthly coupon on the notional balances as set
out below:

<TABLE>
<CAPTION>
NOTIONAL                                          FIXED MONTHLY   FIXED MONTHLY
BALANCE    EFFECTIVE DATE       MATURITY DATE       PAY RATE      RECEIVE RATE
--------  -----------------   -----------------   -------------   -------------
($000'S)                                                (%)                 (%)
<C>       <S>                 <C>                 <C>             <C>
100,000   November 12, 1997   November 15, 1999      6.0550              --
300,000   November 12, 1997   November 15, 2000      6.1325              --
200,000   November 12, 1997   November 15, 2002      6.2150              --
200,000   November 12, 1997   November 15, 2004      6.2650              --
150,000   November 12, 1997   November 15, 2007      6.3600              --
 50,000   November 12, 1997   November 15, 2009      6.4250              --
150,000   February 19, 1998   November 15, 2007          --           5.860
 50,000   February 19, 1998   November 15, 2009          --           5.905
</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 by MSCS. Although MSAF Group's floating rate liability at 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 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.
 
                                       19
<PAGE>   20
 
     At least every three months, 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 Morgan Stanley. 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.
 
                                       20
<PAGE>   21


PART II.          OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

         (a)  Exhibits

              27.1  Financial Data Schedule of Morgan Stanley Aircraft Finance

         (b)  Reports on Form 8-K: Morgan Stanley Aircraft Finance filed a
              Current Report on Form 8-K dated November 12, 1998 and December
              15, 1998 relating to the monthly report to holders of the Notes


                                       21
<PAGE>   22


                                   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: December 24, 1998                          MORGAN STANLEY AIRCRAFT FINANCE


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


                                       22



<PAGE>   23


                                 MORGAN STANLEY AIRCRAFT FINANCE


                                        INDEX TO EXHIBITS


EXHIBIT NUMBER

27.1              Financial Data Schedule of Morgan Stanley Aircraft Finance


                                       23