1. Summary of Significant Accounting Policies

(a) Basis of Presentation: Our unaudited consolidated financial statements include the accounts of Willis Lease Finance Corporation and its subsidiaries (“we” or the “Company”) and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Pursuant to such rules and regulations, certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The accompanying unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2012.

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal and recurring adjustments) necessary to present fairly our financial position as of September 30, 2013 and December 31, 2012, and the results of our operations for the three and nine months ended September 30, 2013 and 2012, and our cash flows for the nine months ended September 30, 2013 and 2012. The results of operations and cash flows for the period ended September 30, 2013 are not necessarily indicative of the results of operations or cash flows which may be reported for the remainder of 2013.

Management considers the continuing operations of our company to operate in one reportable segment.

(b) Fair Value Measurements:

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs, to the extent possible. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis

We hold interest rate derivative instruments to mitigate exposure to changes in interest rates, in particular one-month LIBOR, with $343.5 million and $282.0 million of our borrowings at September 30, 2013 and December 31, 2012, respectively, at variable rates. We measure the fair value of our interest rate swaps of $100.0 million (notional amount) based on Level 2 inputs, due to the usage of inputs that can be corroborated by observable market data. The Company estimates the fair value of derivative instruments using a discounted cash flow technique and, at September 30, 2013, has used creditworthiness inputs that corroborate observable market data evaluating the Company’s and counterparties’ risk of non-performance. We have interest rate swap agreements which have a net liability fair value of $0.3 million and $1.7 million as of September 30, 2013 and December 31, 2012, respectively. For the nine months ended September 30, 2013 and September 30, 2012, $1.1 million and $6.0 million, respectively, were realized as interest expense on the Consolidated Statements of Income.

The following table shows by level, within the fair value hierarchy, the Company’s assets and liabilities at fair value as of September 30, 2013 and December 31, 2012:

	Assets and (Liabilities) at Fair Value
	September 30, 2013										December 31, 2012
	Total			Level 1		Level 2			Level 3		Total			Level 1		Level 2			Level 3
	(in thousands)
Liabilities under derivative instruments	$	(301	)	$	—	$	(301	)	$	—	$	(1,690	)	$	—	$	(1,690	)	$	—
Total	$	(301	)	$	—	$	(301	)	$	—	$	(1,690	)	$	—	$	(1,690	)	$	—

During the nine months ended September 30, 2013 and December 31, 2012, all hedges were effective and no ineffectiveness was recorded in earnings.

Assets Measured and Recorded at Fair Value on a Nonrecurring Basis

We determine the fair value of long-lived assets held and used, such as Equipment held for operating lease and Equipment held for sale, by reference to independent appraisals, quoted market prices (e.g. industry market data) and other factors. An impairment charge is recorded when the carrying value of the asset exceeds its fair value.

The following table shows by level, within the fair value hierarchy, the Company’s assets measured at fair value on a nonrecurring basis as of September 30, 2013 and December 31, 2012, and the gains (losses) recorded during the nine months ended September 30, 2013 and twelve months ended December 31, 2012 on those assets:

									Total Losses
	Assets at Fair Value (in thousands)								Nine Months Ended
	Total		Level 1		Level 2		Level 3		September 30, 2013
									(in thousands)
Balance at September 30, 2013
Equipment held for sale	$	31,506	$	—	$	29,839	$	1,667	$	(6,268	)
Total	$	31,506	$	—	$	29,839	$	1,667	$	(6,268	)

									Total Losses
	Assets at Fair Value (in thousands)								Twelve Months Ended
	Total		Level 1		Level 2		Level 3		December 31, 2012
									(in thousands)
Balance at December 31, 2012
Equipment held for sale	$	23,607	$	—	$	23,384	$	223	$	(5,874	)
Total	$	23,607	$	—	$	23,384	$	223	$	(5,874	)

At September 30, 2013, the Company used Level 2 inputs and, due to a portion of the valuations requiring management judgment due to the absence of quoted market prices, Level 3 inputs to measure the fair value of certain engines that were held as inventory not consigned to third parties. The fair values of the assets held for sale categorized as Level 3 were based on management’s estimate considering projected future sales proceeds at September 30, 2013 and December 31, 2012. An impairment charge is recorded when the carrying value of the asset exceeds its fair value. An asset write-down of $3.5 million was recorded in the nine months ended September 30, 2013 based on a comparison of the asset net book values with the proceeds expected from the sale of engines. A further asset write-down of $2.8 million was recorded in the nine months ended September 30, 2013, based upon a comparison of the asset net book values with the revised net proceeds expected from part sales arising from consignment of the engines. An asset write-down of $4.7 million was recorded in the twelve months ended December 31, 2012 based on a comparison of the asset net book values with the proceeds expected from the sale of engines. A further asset write-down of $1.2 million was recorded in the twelve months ended December 31, 2012, based upon a comparison of the asset net book values with the revised net proceeds expected from part sales arising from consignment of the engines.