10-Q 1 c07235e10vq.txt FORM 10-Q ================================================================================ UNITED STATES 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 June 30, 2006 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 1-8319 GATX FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 94-1661392 (State of incorporation) (I.R.S. Employee Identification No.) 500 WEST MONROE STREET CHICAGO, ILLINOIS 60661-3676 (Address of principal executive offices, including zip code) (312) 621-6200 (Registrant's telephone number, including area code) 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 [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act). [ ] Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The registrant had 1,051,250 shares of $1 par value common stock outstanding (all owned by GATX Corporation) as of July 14, 2006. THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1)(A) AND (B) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE REDUCED DISCLOSURE FORMAT. ================================================================================ GATX FINANCIAL CORPORATION FORM 10-Q QUARTERLY REPORT FOR THE PERIOD ENDED JUNE 30, 2006 INDEX

PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS GATX FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN MILLIONS)

The accompanying notes are an integral part of these consolidated financial statements. 1 GATX FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (IN MILLIONS)

The accompanying notes are an integral part of these consolidated financial statements. 2 GATX FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN MILLIONS)

The accompanying notes are an integral part of these consolidated financial statements. 3 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1. DESCRIPTION OF BUSINESS GATX Financial Corporation ("GFC" or the "Company") is a wholly owned subsidiary of GATX Corporation ("GATX" or the "Parent Company"). GFC is headquartered in Chicago, Illinois and provides services primarily through three operating segments: GATX Rail ("Rail"), GATX Air ("Air"), and GATX Specialty ("Specialty"). GFC specializes in railcar and locomotive leasing, aircraft leasing, and the leasing of other large-ticket equipment. In addition, GFC owns and operates a fleet of self-unloading vessels on the Great Lakes through its wholly owned subsidiary, American Steamship Company ("ASC"). GFC also invests in companies and joint ventures that complement its existing business activities. GFC partners with financial institutions and operating companies to improve its scale in certain markets, broaden its diversification within asset classes and enter new markets. On June 30, 2004, GFC completed the sale of substantially all the assets and related nonrecourse debt of its former Technology segment consisting of GATX Technology Services, its Canadian affiliate and interests in two joint ventures. Financial data for the Technology segment has been segregated as discontinued operations for all periods presented. See Note 11 for additional information on GFC's discontinued operations. NOTE 2. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of GATX Financial Corporation and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by these accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2006 are not necessarily indicative of the results that may be achieved for the entire year ending December 31, 2006. For further information, refer to the consolidated financial statements and footnotes set forth in the Company's Form 10-K/A for the year ended December 31, 2005. Certain reclassifications have been made to the 2005 consolidated financial statements to conform to the 2006 presentation. NOTE 3. NEW ACCOUNTING PRONOUNCEMENTS Accounting for Leveraged Leases -- Prior to 2006, GFC entered into two structured leasing investments that are accounted for in the consolidated financial statements as leveraged leases in accordance with SFAS No. 13, Accounting for Leases. SFAS No. 13 requires total income over the term of a leveraged lease to be recognized on a proportionate basis in those years in which the net investment in a lease is positive. The net investment is based on net cash flows earned from the lease, including the effect of related income taxes. During 2004, the Internal Revenue Service ("IRS") challenged the timing of certain tax deductions claimed with respect to these leveraged leases. GFC believes that its tax position related to these leveraged leases was proper, based upon applicable statutes, regulations and case law in effect at the time the leveraged leases were entered into. GFC and the IRS have entered into a confidential closing agreement with respect to one of the leveraged leases. Resolution with respect to the other transaction has not concluded and may ultimately be litigated. Under existing accounting guidance provided in SFAS No. 13, changes in estimates or assumptions not affecting estimated total net income from a leveraged lease, including the timing of income tax cash flows, do not change the timing of leveraged lease income recognition. In July, 2006, the Financial Accounting Standards Board ("FASB") issued Staff Position ("FSP") No. FAS 13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction. The guidance outlined in this FSP applies to all transactions classified as leveraged leases in accordance with SFAS No. 13 and requires that the expected timing of income tax cash flows generated by a leveraged lease transaction be reviewed annually or more frequently if events or changes in circumstances indicate that a change in timing has occurred or is projected to occur. If, during the lease term, the expected timing of income tax cash flows generated by a leverage lease is revised, the rate of return and the allocation of income would be recalculated from the inception of the lease following the methodology provided in SFAS No. 13, which may result in a one-time, non-cash charge to earnings in the period of 4 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) changed expectations. An equivalent amount of any such adjustment would then be recognized as income over the remaining term of the applicable lease. Over the full term of these leases the cumulative accounting income would not change. This FSP is effective for fiscal years beginning after December 15, 2006. The application of this FSP is not expected to be material to the Company's consolidated financial position or results of operations. In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN48"), which is an interpretation of SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 does not prescribe a recognition threshold or measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. FIN 48 clarifies the application of SFAS No. 109 by defining criteria that an individual tax position must meet for any tax benefit to be recognized in an enterprise's financial statements. Additionally, FIN 48 provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006. GFC is currently evaluating the impact of adopting this interpretation. NOTE 4. INVESTMENTS IN AFFILIATED COMPANIES Investments in affiliated companies represent investments in, and loans to and from, domestic and foreign companies and joint ventures that are in businesses similar to those of GFC, such as lease financing and related services for customers operating commercial aircraft, rail, marine and industrial equipment assets, as well as other business activities, including ventures that provide asset residual value guarantees in both domestic and foreign markets. For purposes of preparing the following information, GFC made adjustments to the operating results reported by certain of its affiliates. GFC recorded its loans to certain affiliates as equity contributions. As a result, the affiliates' loan balances were reclassified from liabilities to equity and pre-tax income was adjusted to reverse related interest expense. Additionally, the impacts of any basis differences between GFC's carrying value and its share of the affiliates' net assets, including the effects of impairment losses recorded by GFC at the investor level, are not reflected in the operating results of the affiliates. Operating results for GFC's affiliates assuming GFC held a 100% interest, were (in millions):

NOTE 5. PENSION AND OTHER POST-RETIREMENT BENEFITS GFC participates in pension plans sponsored by GATX that cover substantially all of its employees. Benefits payable under the pension plans are based on years of service and/or final average salary. In addition GFC employees participate in GATX's other post-retirement plans that provide health care, life insurance and other benefits for certain retired domestic employees who meet established criteria. Most domestic employees are eligible for health care and life insurance benefits if they retire from GATX with immediate benefits under the GATX pension plan. Periodic costs pertaining to the GATX plans are allocated to GFC on the basis of payroll costs with respect to normal cost and on the basis of actuarial determinations for prior service cost. Allocated costs for continuing operations for the three months ended June 30, 2006 and 2005 were $0.9 million and $1.0 million, respectively. Allocated costs for continuing operations for the six months ended June 30, 2006 and 2005 were $1.8 million and $2.0 million, respectively. Plan benefit obligations, plan assets, and the components of net periodic costs for individual subsidiaries of GATX, including GFC, have not been determined. NOTE 6. GUARANTEES In connection with certain investments or transactions, GFC has entered into various commercial commitments, such as guarantees and standby letters of credit, which could potentially require performance in the event of demands by third parties. Similar to GFC's balance sheet investments, these guarantees expose GFC to credit, market and equipment risk; accordingly, GFC evaluates its commitments and other contingent obligations using techniques similar to those used to evaluate funded transactions. 5 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) The following table sets forth GFC's guarantees as of (in millions):

At June 30, 2006, the maximum potential amount of guarantees under which GFC or its subsidiaries could be required to perform was $606.1 million. The related carrying value of the guarantees on the balance sheet, including deferred revenue primarily associated with residual value guarantees entered into prior to the effective date of FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, was a liability of $1.2 million. The expirations of these guarantees, except for GFC's Other guarantee, the term of which is uncertain, range from 2007 to 2017. Any liability resulting from GFC's performance pursuant to the residual value guarantees will be reduced by the value realized from the underlying asset or group of assets. Historically, gains associated with the residual value guarantees have exceeded any losses and were recorded in asset remarketing income in the consolidated statements of operations. Based on known facts and current market conditions, management does not believe that the asset residual value guarantees will result in any significant adverse financial impact to the Company. Accordingly, the Company has not recorded any accrual for contingent losses with respect to the residual value guarantees as of June 30, 2006. GFC believes these asset residual value guarantees will likely generate future income in the form of fees and residual sharing proceeds. Affiliate guarantees generally involve guaranteeing an affiliate's repayment of the financing it utilized to acquire or lease in assets that it leases to customers, and are in lieu of making direct equity investments in the affiliate. GFC is not aware of any event of default which would require it to satisfy these guarantees, and expects the affiliates to generate sufficient cash flow to satisfy their lease and loan obligations. Asset residual value guarantees represent GFC's commitment to third parties that an asset or group of assets will be worth a specified amount at the end of a lease term. Revenue is earned for providing these asset value guarantees in the form of an initial fee (which is amortized into income over the period of the guarantee) and by sharing in any proceeds received upon disposition of the assets to the extent such proceeds are in excess of the amount guaranteed (which is recorded when realized). Lease payment guarantees represent GFC's guarantees to financial institutions of finance and operating lease payments of an unrelated party in exchange for a fee. GFC's Other guarantee represents an indemnification of Airbus Industrie ("Airbus") related to the dissolution of Flightlease Holdings Limited ("FHG") and the allocation by Airbus of $77.8 million of pre-delivery payments to GFC towards the purchase of aircraft in 2001. These pre-delivery payments are also the subject of active litigation. No liability has been recorded with respect to this indemnification as GFC believes that the likelihood of having to perform under the indemnity is remote. GFC and its subsidiaries are also parties to standing letters of credit and bonds primarily related to workers' compensation and general liability insurance overages. No material claims have been made against these obligations. At June 30, 2006, management does not expect any material losses to result from these off balance sheet instruments because performance is not expected to be required. NOTE 7. VARIABLE INTEREST ENTITIES GFC has ownership interests in certain investments that are considered Variable Interest Entities ("VIEs") in accordance with FASB Interpretation No. 46R, Consolidation of Variable Interest Entities. GFC does not believe it is the primary beneficiary with respect to any of the VIEs. As a result, GFC does not consolidate these entities. GFC's maximum exposure to loss with respect to these VIEs is approximately $243.1 million of which $217.8 million was the aggregate carrying value of these investments recorded on the balance sheet at June 30, 2006. 6 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) NOTE 8. COMPREHENSIVE INCOME The components of comprehensive income were as follows (in millions):

NOTE 9. ADVANCES TO PARENT Interest income on advances to GATX, which is included in gross income was $6.1 million for the three months ended June 30, 2006 compared to $6.5 million in the prior year quarter. For the six months ended June 30, 2006 interest income on advances was $12.3 million compared to $12.7 million in the prior year period. These advances have no maturity date. Interest income on advances to GATX is based on an interest rate that is adjusted annually in accordance with an estimate of applicable rates. NOTE 10. FINANCIAL DATA OF BUSINESS SEGMENTS The financial data presented below conforms to SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, and depicts the profitability, financial position and capital expenditures of each of GFC's continuing business segments. Segment profitability is presented to reflect operating results inclusive of allocated corporate support expenses. GFC provides services primarily through three operating segments: Rail, Air and Specialty. In addition, GFC operates a fleet of self-unloading vessels on the Great Lakes through its wholly owned subsidiary, American Steamship Company. Rail is principally engaged in leasing rail equipment, including tank cars, freight cars and locomotives. Rail provides full-service leases under which Rail maintains and services the railcars, pays ad valorem taxes, and provides other ancillary services. Rail also provides net leases, under which the lessee is responsible for maintenance, insurance and taxes. Air is principally engaged in leasing narrowbody aircraft to airlines throughout the world. Air typically provides net leases under which the lessee is responsible for maintenance, insurance and taxes. Air also engages in fee based aircraft management activities that involve remarketing and sales efforts on behalf of clients. Specialty is principally engaged in pursuing investment opportunities in marine assets and long-lived industrial equipment in targeted industries. Specialty also provides portfolio management services that generate income, some of which is based on the residual value of the equipment under management. The Specialty portfolio consists primarily of leases, loans, joint venture investments and interests in residual values involving a variety of underlying asset types, including marine, aircraft, rail, industrial and other equipment. Other is comprised of corporate results, including SG&A expenses and interest expense not allocated to segments, and the operating results of ASC. Management evaluates the performance of each segment based on several measures, including net income. These results are used to assess performance and determine resource allocation among the segments. 7 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) GFC allocates corporate SG&A and applicable interest expense to its segments. Corporate SG&A expenses relate to administration and support functions performed at the corporate office. Such expenses include information technology, human resources, legal, tax, financial support and executive costs. Directly attributable expenses are generally allocated to the segments and shared costs are retained in Other. Amounts allocated to the segments are approximated based on management's best estimate and judgment of direct support services. Debt balances and interest expense were allocated based upon a fixed recourse leverage ratio for each individual operating segment across all reporting periods, expressed as a ratio of recourse debt (including off balance sheet debt) to equity. Unallocated debt and interest were retained in Other. Beginning in 2006, GFC modified its methodology for calculating the estimated value of its off balance sheet debt, which is based on the present value of committed future operating lease payments. GFC now uses the implicit interest rate in each of its operating leases as the discount rate in calculating the present value amount, whereas it previously used a fixed 10% discount rate. This modification generally resulted in a lower discount rate and therefore a higher calculated off balance sheet debt amount. In connection with this methodology change, GFC also modified the recourse leverage ratios assigned to each segment. For 2006, the recourse leverage ratios for Rail, Air and Specialty were set at 4.75:1, 3:1 and 4:1, respectively. For 2005, the leverage ratios were 4.5:1, 3:1 and 4:1, respectively. In the aggregate, the amount of debt and interest expense allocated to each segment on the basis of the 2006 method approximated the amounts that would have been allocated under the prior method. Management believes this leverage and interest expense allocation methodology provides a reasonable approximation of each operating segment's risk-adjusted financial return. 8 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) The following tables present certain segment data for the three and six months ended June 30, 2006 and 2005 (in millions):

9 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)

NOTE 11. DISCONTINUED OPERATIONS On June 30, 2004, substantially all of the assets of GATX Technology Services and its Canadian affiliate were sold with $291.5 million of related nonrecourse debt assumed by the acquirer. The remaining assets, consisting primarily of interests in two joint ventures, were sold prior to December 31, 2004. Financial data for the Technology segment has been segregated as discontinued operations for all periods presented. The following table summarizes the operating results of the Technology segment, for all periods presented (in millions):

The following tables summarize the components of discontinued operations reported on the consolidated statements of cash flows (in millions):

In the six month period ended June 30, 2005, Technology received final distributions totaling $9.1 million associated with the 2004 sale of a joint venture interest. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS The following discussion and analysis should be read in conjunction with the unaudited financial statements included herein. Certain statements within this document may constitute forward-looking statements made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These statements are identified by words such as "anticipate," "believe," "estimate," "expect," "intend," "predict," or "project" and similar expressions. This information may involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Risks and uncertainties include, but are not limited to, general economic conditions; lease rates, utilization levels and operating costs in GFC's primary asset segments; conditions in the capital markets; changes in GFC's credit ratings; dynamics affecting companies within the markets served by GFC; regulatory rulings that may impact the economic value and operating costs of assets; competitive factors in GFC's primary markets including lease pricing and asset availability; changes in loss provision levels within GFC's portfolio; impaired asset charges that may result from changing market conditions or implementation of portfolio management initiatives by GFC; the outcome of pending or threatened litigation and general market conditions in the rail, air, marine and other large-ticket industries. Other factors and unanticipated events could adversely affect our business operations and financial performance. We discuss certain of these matters more fully, as well as certain risk factors that may affect our business operations, financial condition and results of operations, in other of our filings with the SEC, including our Annual Report on Form 10-K/A. These risks, uncertainties and other factors should be carefully considered in evaluating the forward-looking statements. The forward-looking statements included in this Quarterly Report are made only as of the date of this report, and we undertake no obligation to update these forward-looking statements to reflect subsequent events or circumstances. BUSINESS OVERVIEW GATX Financial Corporation ("GFC" or the "Company") is a wholly owned subsidiary of GATX Corporation ("GATX" or the "Parent Company"). GFC is headquartered in Chicago, Illinois and provides services primarily through three operating segments: GATX Rail ("Rail"), GATX Air ("Air"), and GATX Specialty ("Specialty"). GFC specializes in railcar and locomotive leasing, aircraft leasing, and the leasing of other large-ticket equipment. In addition, GFC operates a fleet of self-unloading vessels on the Great Lakes through its wholly owned subsidiary, American Steamship Company ("ASC"). GFC also invests in companies and joint ventures that complement existing business activities. GFC partners with financial institutions and operating companies to improve scale in certain markets, broaden diversification within asset classes and enter new markets. Operating results for the six months ended June 30, 2006 are not necessarily indicative of the results that may be achieved for the entire year ending December 31, 2006. For further information, refer to GFC's Annual Report on Form 10-K/A for the year ended December 31, 2005. 11 FINANCIAL SUMMARY The following table presents net income by segment for the periods indicated (in millions):

GATX RAIL Components of Rail's income statements are summarized below (in millions):

12 RAIL'S FLEET DATA The following table summarizes the railcar activity for Rail's North American fleet for the six months ended June 30:

COMPARISON OF THE FIRST SIX MONTHS OF 2006 TO THE FIRST SIX MONTHS OF 2005. SUMMARY Rail continued to benefit from favorable conditions in its markets during the first six months of 2006. In both North America and Europe, strong demand contributed to high lease renewal success, increased lease rates and historically high levels of fleet utilization. In the second quarter of 2006, the average North American renewal lease rate on a basket of common car types increased 15.4% on average over the expiring rate. Additionally, Rail is extending term on certain renewals, an action that is expected to temper future earnings volatility. Utilization is expected to remain high throughout the remainder of 2006 and with over 11,000 railcars up for renewal in North America over the balance of the year, GFC expects lease income in 2006 to continue to increase as expiring leases are expected to be renegotiated at higher rates. During the first six months of 2006, Rail invested $161.6 million, acquiring approximately 2,100 railcars and 46 locomotives. Investment volume for the comparable period of 2005 totaled $150.6 million for approximately 2,300 railcars and 11 locomotives. In the first six months of 2006, Rail also exercised two purchase options on approximately 4,700 railcars leased in under operating leases for an aggregate cost of $260.9 million. Rail's net income of $60.2 million for the first six months of 2006 was $17.1 million higher than the prior year period. The increase was driven primarily by an average of 3,100 more railcars on lease than the comparable period of 2005, an increase in lease rates over the last 18 months on lease renewals and assignments and a $5.9 million deferred tax benefit, recorded in the second quarter of 2006, from a reduction in Canadian statutory tax rates. GROSS INCOME Rail's 2006 gross income of $433.7 million for the first six months was $24.3 million higher than the prior year period. In North America, lease income increased $22.8 million, due primarily to higher lease rates and, on average, 2,300 more cars on lease compared to the first six months of 2005. Locomotive leasing contributed $1.1 million to the increase due to higher lease rates and higher utilization. In Europe, 2006 lease income was $1.5 million higher than the prior year as the impact of, on average, 800 additional railcars on lease was partially offset by the effect of foreign currency exchange differences. Asset remarketing income increased $3.5 million versus the prior year period. Rail capitalized on the stronger 2006 market conditions by selling certain less desirable railcar types, resulting in a $5.7 million remarketing gain. Lower other income in 2006 primarily reflects lower repair revenues on third party railcars and the absence of an insurance recovery received in the prior year period, partially offset by higher gains in 2006 on the scrapping of railcars. Repair revenues were lower in 2006 due to increased focus at GFC's major service centers on maintaining GFC's growing North American fleet over third party railcars. Scrapping gains were higher in 2006 due to an increase in the price of steel. The decrease in share of affiliates' earnings versus the prior year period primarily reflects a $4.0 million asset remarketing gain recognized at a domestic joint venture in 2005. The decrease was partially offset by improved results and favorable market value adjustments on certain derivative financial instruments at the AAE Cargo affiliate. 13 OWNERSHIP COSTS Ownership costs of $201.5 million were $6.1 million higher than the prior year, reflective of increased interest costs and depreciation associated with Rail's asset acquisitions. Higher interest rates in 2006 also impacted interest expense. Over the past 18 months, Rail has invested approximately $560 million in railcar acquisitions and existing railcar improvements. The comparative mix among the ownership cost components of depreciation, interest and operating lease expense was impacted by sale leaseback activity and the purchase of railcars leased in under operating leases. In 2005, Rail completed a sale leaseback transaction for 2,900 railcars with a net book value of $170.0 million. In 2006, Rail exercised purchase options on two operating leases for 2,700 and 2,000 railcars respectively, for an aggregate cost of $260.9 million. OTHER COSTS AND EXPENSES Maintenance expense increased $4.5 million from the prior year period to $98.2 million. The increase primarily reflects a larger fleet and increased repairs performed by North American railroads in 2006. The current year also includes added expense associated with the conversion and reconfiguration of certain railcars for use in difference types of services. Rail continues to face the possibility of newly mandated security or safety legislation or regulations that, if enacted, may increase future maintenance costs or negatively impact asset valuations. Selling, general and administrative costs were $4.6 higher than the prior year period. The increase was primarily related to increased employee and information technology costs in North America, partially offset by lower employee costs in Europe related to integration activities executed in 2005. Other expenses were $4.8 million lower than the prior year period. The decrease was primarily due to lower claims related expenses and favorable foreign currency exchange rates. Asset impairment charges in the prior year period included the write down of a repair facility that was held for sale and the writedown of certain European locomotives. The repair facility was sold during the current year period at its adjusted book value. TAXES See "Consolidated Income Taxes" for a discussion of GFC's consolidated income tax expense. COMPARISON OF SECOND QUARTER 2006 TO SECOND QUARTER 2005 SUMMARY Rail's net income of $35.4 million for the second quarter of 2006 was $12.3 million higher than the prior year period. The increase was driven primarily by an average of 2,800 more railcars on lease than the prior period, an increase in lease rates over the last 18 months on lease renewals and assignments and a $5.9 million deferred tax benefit, recorded in the second quarter of 2006, from a reduction in Canadian statutory tax rates. Partially offsetting the increase were higher ownership and maintenance costs on the larger active fleet. GROSS INCOME Rail's 2006 gross income of $219.0 million for the second quarter of 2006 was $13.6 million higher than the prior year period. In North America, lease income increased $11.2 million, reflecting the effects of higher lease rates and, on average, 2,300 more cars on lease compared to the second quarter of 2005. In Europe, lease income was $1.0 million higher than the prior year period as the impact of an average of 500 additional railcars on lease contributed favorably to results. Asset remarketing income increased $4.4 million versus the prior year period. Rail capitalized on the stronger 2006 market conditions by selling certain less desirable railcar types, resulting in a $5.7 million remarketing gain. Lower other income in 2006 primarily reflects lower repair revenues on third party railcars and the absence of an insurance recovery received in the prior year period, partially offset by higher gains on the scrapping of railcars. Repair revenues were lower in 2006 due to increased focus at GFC's major service centers on maintaining GFC's growing North American fleet over third party railcars. Scrapping gains were higher in 2006 due to an increase in the price of steel. The decrease in share of affiliates' earnings versus the prior year period reflects a large asset remarketing gain recognized 14 by an affiliate in 2005. The decrease was partially offset by improved results and favorable market value adjustments on certain derivative financial instruments at the AAE Cargo affiliate. OWNERSHIP COSTS Ownership costs of $101.5 million were $5.8 million higher than the prior year period, reflective of increased interest costs and depreciation associated with Rail's asset acquisition activity. Higher interest rates in 2006 also impacted interest expense. The comparison of depreciation, interest and operating lease expense was impacted by Rail's exercise of a purchase option at the end of the first quarter of 2006 on 2,700 railcars leased in under an operating lease for an aggregate cost of $160.6 million. A second purchase option for $100.3 million, covering 2,000 railcars, was exercised at the end of the second quarter of 2006. OTHER COSTS AND EXPENSES Maintenance expense increased $1.6 million from the prior year period to $47.1 million. The increase reflects the costs associated with maintaining a larger fleet, increased repairs performed by North American railroads and greater compliance work in 2006. The current year period also includes added expense associated with the conversion and reconfiguration of certain railcars for use in different types of services. Rail continues to face the possibility of newly mandated security or safety legislation or regulations that, if enacted, may increase future maintenance costs or negatively impact asset valuations. Selling, general and administrative costs were $3.0 higher than the prior year period. The increase was primarily related to increased employee costs and increased information technology costs in North America, partially offset by lower employee costs in Europe related to integration activities executed in 2005. Other expenses were $3.7 million lower than the prior year period. The decrease was primarily due to lower claims related expenses and favorable foreign currency exchange gains. GATX AIR Components of Air's income statements are summarized below (in millions):

15 AIR'S FLEET DATA The following table summarizes information on GFC owned and managed aircraft as of June 30:

(A) Includes wholly owned and partnered aircraft COMPARISON OF THE FIRST SIX MONTHS OF 2006 TO THE FIRST SIX MONTHS OF 2005. SUMMARY The airline industry continues to benefit from improved worldwide airline traffic while continuing to be sensitive to higher fuel prices and other global political, economic and health-related events. Lease rates have remained firm as demand for narrowbody aircraft continues to be strong. Air is focused on improving financial returns through increasing aircraft management engagements and by optimizing its existing fleet. In the first six months of 2006, Air was successful in expanding its aircraft management activities, resulting in fee income of $7.9 million, a 92.7% increase over the prior year. Air continues to pursue aircraft management opportunities, which include remarketing and sales efforts on behalf of clients. The timing of income from these activities will depend on transactional opportunities and is expected to be uneven in nature. In December 2005, Air targeted 36 aircraft, comprised of 12 wholly owned and 24 held by affiliates, for disposition and began reviewing alternatives for its 50% owned affiliate, Pembroke. Air expects that the disposition of the targeted aircraft will be substantially completed by year end. In the first six months of 2006, two of the targeted aircraft were placed on short term direct finance leases and the sale of Air's interest in Pembroke was completed in July 2006. Additionally, Air took delivery of one new aircraft in June 2006, which was immediately placed on lease. Air's net income of $13.9 million for the first six months of 2006 was $9.1 million higher than the prior year period. Comparability between periods was affected by lower depreciation expense of $7.0 million (after tax) and asset impairment charges of $6.8 million (after tax) recorded in 2006 on aircraft targeted for disposition and an operating lease charge of $3.0 million (after tax) recorded in 2005. Excluding the effects of these events, the 2006 increase in income was primarily attributable to higher lease and fee income and lower SG&A expense. GROSS INCOME Gross income of $98.3 million was $12.5 million higher than the prior year period primarily due to increased lease income, fees and share of affiliates' earnings. Lease income was $6.1 million higher than the prior year due to the impact of higher interest rates on variable rate leases partially offset by the absence of income from four aircraft transferred to a newly formed partnership in 2005 and from two aircraft that were off-lease while transitioning between lessees in 2006. Fee income of $7.9 million was $3.8 million higher than the prior year primarily due to fees earned for managing the sale of aircraft on behalf of third parties. Share of affiliates' earnings increased $3.7 million over the comparable 2005 period primarily due to current year earnings from the new partnership formed in 2005, the impact of higher interest rates on variable rate leases, and lower depreciation expense in the current year on certain joint venture aircraft held for sale or whose book values were written down in December 2005. The increase was partially offset by lower asset remarketing gains in the Rolls-Royce engine leasing affiliate. OWNERSHIP COSTS Ownership costs of $52.8 million were $11.4 million lower than the prior year. Depreciation expense decreased $8.4 million primarily due to the absence of depreciation in 2006 on aircraft classified as held for sale. Interest expense increased $1.8 million due to higher interest rates on variable rate debt, largely offset by the impact of lower average debt balances. Operating lease expense in 2006 was lower due to a charge of $4.8 million related to the restructuring of a lease with a bankrupt carrier recorded in the prior year. 16 OTHER COSTS AND EXPENSES Other costs and expenses of $23.8 million were $9.1 million higher than the prior year. The asset impairment charges in the current period resulted primarily from the net change in estimated fair value of the remaining held for sale aircraft, partially offset by the reversal of maintenance reserves related to two held for sale aircraft that were placed on direct finance leases. Air expects that results for the remainder of 2006 will continue to include gains and losses as additional fair value remeasurements and/or final disposition results for held for sale aircraft are recognized. SG&A expense was lower primarily due to the capitalization of initial direct costs related to the new aircraft placed on lease. TAXES See "Consolidated Income Taxes" for a discussion of GFC's consolidated income tax expense. COMPARISON OF SECOND QUARTER 2006 TO SECOND QUARTER 2005 Air's net income of $2.6 million for the three months ended June 30, 2006 was $2.6 million higher than the prior year period. Comparability between periods was affected by lower depreciation expense of $3.6 million (after tax) and additional net impairment charges of $7.3 million (after tax) recorded in 2006, and an operating lease charge of $3.0 million (after tax) recorded in 2005. Excluding these events, the increase was primarily attributable to higher lease income and fees and lower SG&A expense. GROSS INCOME Gross income of $48.9 million was $6.8 million higher than the prior year period primarily due to increased lease income, fees and share of affiliates' earnings. Lease income was $5.1 million higher than the prior year due to the impact in 2006 of higher interest rates on variable rate leases. Fee income of $3.4 million was $1.5 million higher than the prior year primarily due to fees earned for managing the sale of aircraft on behalf of third parties. Share of affiliates' earnings increased $0.3 million over the comparable 2005 period primarily due to the impact in 2006 of higher interest rates on variable rate leases and lower depreciation expense in the current year on certain joint venture aircraft held for sale or whose book values were written down in December 2005. The impact of these items more than offset the absence of the gains on sale recorded at Air's engine leasing joint venture and the reversal of repossession expense accruals, which were recorded in the prior 2005 period. OWNERSHIP COSTS Ownership costs of $27.0 million were $7.7 million lower than the prior year. Depreciation expense decreased $3.7 million primarily due to the absence of depreciation in 2006 on aircraft classified as held for sale. Interest expense increased $0.9 million due to higher interest rates on variable rate debt, largely offset by the impact of lower average debt balances. Operating lease expense in the second quarter of 2006 was lower due to a one-time charge of $4.8 million related to the restructuring of a lease with a bankrupt carrier recorded in the prior year. OTHER COSTS AND EXPENSES Other costs and expenses of $17.9 million were $10.4 million higher than the prior year. The asset impairment charges in the current period resulted primarily from the net change in estimated fair value of the remaining held for sale aircraft, partially offset by the reversal of maintenance reserves related to one held for sale aircraft that was placed on a six month direct finance lease. Air expects that results for the remainder of 2006 will continue to include gains and losses as additional fair value remeasurements and/or final disposition results for held for sale aircraft are recognized. SG&A expense was lower primarily due to the capitalization of initial direct costs related to the new aircraft placed on lease. 17 GATX SPECIALTY Components of Specialty's income statements are summarized below (in millions):

SPECIALTY'S PORTFOLIO DATA The following table summarizes information on the owned and managed Specialty portfolio as of June 30 ($ in millions):

(A) Includes off balance sheet assets 18 COMPARISON OF THE FIRST SIX MONTHS OF 2006 TO THE FIRST SIX MONTHS OF 2005. SUMMARY During the first six months of 2006, Specialty's net book value of owned assets increased $24.4 million to $462.8 million, reflecting GFC's renewed efforts to grow this segment by following a disciplined approach that focuses on marine and select industrial equipment assets. In 2006, Specialty invested $54.4 million, including $40.3 million for industrial equipment assets and $13.0 million in marine assets. Specialty's net income of $26.8 million for the first six months of 2006 was $7.0 million lower than the prior year period. The decrease was primarily due to lower gains from the sale of securities and lower share of affiliates' earnings in the current year. GROSS INCOME Gross income of $67.6 million was $7.3 million lower than the prior year. The decrease was primarily due to lower gains on the sale of securities and share of affiliates' earnings, partially offset by higher lease income. The increase of $3.4 million in lease income was primarily due to new investments in operating lease assets. Interest income decreased $1.9 million as a result of the run-off of Venture Finance and other portfolio loans during 2005. Asset remarketing, for both 2006 and 2005, primarily reflects gains and fees received in each period from sales of assets and related transactions in the managed portfolios. Significant residual sharing fees of $14.0 million and $12.8 million were received in 2006 and 2005, respectively, related to one transaction. The timing of asset remarketing income is dependant on transactional opportunities and market conditions and is expected to be uneven in nature. Other income decreased $4.4 million primarily due to a $3.7 million gain from the sale of securities recorded in the prior year. Share of affiliates' earnings of $19.5 million decreased $2.5 million primarily as a result of decreased operating earnings from the marine joint ventures. These joint ventures continue to post strong earnings in 2006, however, not at the historically high levels experienced in 2005. OWNERSHIP COSTS Ownership costs of $14.4 million increased $0.3 million primarily as a result of increased depreciation expense related to new portfolio investments. OTHER COSTS AND EXPENSES Other costs and expenses of $8.1 million increased $2.0 million primarily due to asset impairment charges recorded in the current year on certain cost method investments. TAXES See "Consolidated Income Taxes" for a discussion of GFC's consolidated income tax expense. 19 COMPARISON OF SECOND QUARTER 2006 TO SECOND QUARTER 2005 Specialty's net income of $8.4 million for the three months ended June 30, 2006 was $15.4 million lower than the prior year period. The decrease was primarily due to lower asset remarketing income and share of affiliates' earnings in the current year. GROSS INCOME Gross income of $25.2 million was $22.4 million lower than the prior year. The decrease was primarily due to lower asset remarketing, and share of affiliates' earnings, partially offset by higher lease income. The increase of $1.8 million in lease income was primarily due to new investments in operating lease assets. Asset remarketing was $2.7 million in the second quarter of 2006 compared to $21.0 million in the prior year, which included a residual sharing fee of $12.8 million on one transaction. The timing of asset remarketing income is dependant on transactional opportunities and market conditions and is expected to be uneven in nature. Interest income decreased $0.9 million as result of the run-off of Venture Finance and other portfolio loans during 2005. Other income includes gains on the sale of securities, which decreased by $0.6 million from the prior year. Share of affiliates' earnings of $9.6 million decreased $3.0 million primarily as a result of decreased earnings from the marine joint ventures. These joint ventures continue to post strong earnings in 2006, however, not at the historically high levels experienced in 2005. OWNERSHIP COSTS Ownership costs of $7.2 million increased $0.1 million primarily as a result of increased depreciation expense related to new portfolio investments. OTHER COSTS AND EXPENSES Other costs and expenses of $2.8 million increased $0.8 million primarily due to currency fluctuations, partially offset by a larger reversal of provision for losses in the current year. OTHER Components of the income statements are summarized below (in millions):

20 COMPARISON OF THE FIRST SIX MONTHS OF 2006 TO THE FIRST SIX MONTHS OF 2005. SUMMARY Other is comprised of corporate results, including selling, general and administrative expenses ("SG&A") and interest expense net of amounts allocated to the segments, and the results of ASC. Other reported net income of $17.5 million in 2006, compared to net income of $10.6 million reported in 2005. Other income includes interest on advances to GATX of $12.3 million and $12.7 million in 2006 and 2005, respectively. The prior year results included $11.9 million ($7.4 million after-tax) of debt extinguishment costs primarily related to fees associated with liability management activities. Specifically, during the second quarter of 2005, GFC completed a bond tender for an aggregate principal amount of $188.4 million of debt scheduled to mature in 2006 and prepaid in excess of $110.0 million of higher cost secured borrowings. Excluding the impact of the debt extinguishment costs, 2006 results were comparable to 2005. An increase in interest expense in 2006 was largely offset by higher income at ASC. The increased interest expense was due to finance costs resulting from ASC's fleet acquisitions and higher unallocated interest. The higher ASC net income was driven primarily by new vessels added to ASC's fleet, which led to significantly higher marine operating revenues and expenses. One vessel was added at the end of the second quarter of 2005 and six additional vessels were acquired from Oglebay Norton Marine Services in June of 2006. COMPARISON OF SECOND QUARTER 2006 TO SECOND QUARTER 2005 SUMMARY Other reported net income of $10.3 million in 2006, compared to net income of $3.4 million reported in 2005. Other income includes interest on advances to GATX of $6.1 million and $6.5 million in 2006 and 2005, respectively. The prior year results included $11.9 million ($7.4 million after-tax) of debt extinguishment costs primarily related to fees associated with liability management activities. Excluding the impact of the debt extinguishment costs, 2006 results were comparable to 2005. An increase in interest expense in 2006 was largely offset by higher income at ASC. The increased expense was due to finance costs resulting from ASC's fleet acquisitions and higher unallocated interest. The higher ASC net income was driven by the new vessels added to ASC's fleet. GFC CONSOLIDATED CONSOLIDATED INCOME TAXES GFC's effective tax rate was 33% for the six months ended June 30, 2006 compared to 36% for the six months ended June 30, 2005. The decrease in 2006 was primarily driven by a deferred tax benefit of $5.9 million resulting from a Canadian statutory rate change enacted in the second quarter of 2006. Excluding the deferred tax benefit, GFC's 2006 year to date tax rate approximated 36%, which reflects the impact of state income taxes, partially offset by lower tax rates on foreign source income. CASH FLOW AND LIQUIDITY Over the course of a full year, GFC expects to generate significant cash flow from a combination of operating activities and investment portfolio proceeds. This cash flow is used to satisfy GFC's cash needs for investing and financing activities, such as servicing debt, paying dividends, and funding portfolio investments and capital additions. Cash flow from operations and portfolio proceeds are impacted by changes in working capital and the timing of asset dispositions. As a result, cash flow components will vary across reporting periods. The following discussion of cash flow activity is presented excluding the impact of discontinued operations. Net cash provided by continuing operations for the first six months of 2006 was $209.6 million, an increase of $65.3 million from the prior year period. Higher lease income and the absence of debt extinguishment costs were partially offset by higher finance costs and other changes in working capital. Portfolio investments and capital additions for the six months of 2006 totaled $392.8 million, an increase of $205.1 million from the comparable 2005 period. Rail's investments of $161.6 million were $11.0 million higher than the prior year period and included the addition of approximately 2,100 railcars to its fleet. Air's investments of $49.1 million in 2006 consisted primarily of the final payment for delivery of one new Airbus 320-200 aircraft. Air had only nominal investing activity in the prior year period. Specialty invested $54.4 million in 2006, an increase of $22.8 million from the prior year period. Significant 2006 activity at Specialty included $40.3 million of investments in select long-lived industrial equipment and $13.0 in marine assets. ASC invested $123.9 million in 2006, adding six vessels acquired from Oglebay Norton Marine Services to its fleet. Additionally, in 2006, Rail exercised purchase options on two operating leases covering 4,700 railcars for an aggregate cost of $260.9 million. 21 Portfolio proceeds were $99.0 million for the first six months of 2006 compared to $192.6 million for the prior year period. Proceeds for the first six months of 2005 included $62.7 million related to the transfer of four aircraft to a newly formed joint venture in which the Company had a 50% interest. In 2006, GFC sold half of its 50% interest in this joint venture for $30.6 million. Additionally, in 2005, a sale-leaseback transaction was executed on approximately 2,900 railcars for total proceeds of $201.3 million. GFC also expects to satisfy its cash needs for investing and financing activities through the use of uncommitted money market lines, commercial paper, committed revolving credit facilities, the issuance of unsecured debt, and a variety of secured borrowings. GFC utilizes both domestic and international banks and capital markets. In the first six months of 2006, GFC issued long-term debt for net proceeds of $345.1 million, primarily consisting of $200.0 million of ten-year senior unsecured notes and a $100.0 million seven-year unsecured term loan. GFC also issued a net amount of $304.7 million of commercial paper. Debt repaid in 2006 consisted primarily of scheduled maturities and certain bank credit facilities. Subsequent to June 30, 2006, the proceeds from the term loan were used to reduce commercial paper outstanding. GFC has a $525.0 million five-year senior unsecured revolving facility which matures in June 2010. At June 30, 2006, availability under the credit facility was $201.0 million, with $19.3 million of letters of credit issued and $304.7 million of commercial paper outstanding, both backed by the facility. The revolving credit facility contains various restrictive covenants, including requirements to maintain a defined net worth, an asset coverage test, and a fixed charge coverage ratio. At June 30, 2006, GFC was in compliance with all covenants and conditions of the credit facility. The indentures for GFC's public debt also contain restrictive covenants, including limitations on loans, advances or investments in related parties (including the Parent Company) and dividends it may distribute to the Parent Company. Certain of the indentures contain limitation on liens provisions that limit the amount of secured indebtedness GFC may incur. At June 30, 2006, GFC was in compliance with the covenants and all conditions of the indentures. A subsidiary financing contains leverage and cash flow covenants that are specific to the subsidiary. GFC does not anticipate any covenant violations in either the credit facility, bank financing, or indentures, nor does GFC anticipate that any of these covenants will restrict its operations or its ability to procure additional financing. As of June 30, 2006, GFC had a shelf registration for $1.0 billion of debt securities and pass through certificates from which $496.5 million of senior unsecured notes had been issued. The availability of these funding options may be affected by certain factors including the global capital market environment and outlook as well as GFC's financial performance. Access to capital markets at competitive rates is dependent on GFC's credit rating and rating outlook, as determined by rating agencies such as Standard & Poor's ("S&P") and Moody's Investors Service ("Moody's"). In January of 2006, S&P upgraded its credit rating on GFC's long-term unsecured debt to BBB from BBB- and changed GFC's rating outlook to stable. Also, S&P's credit rating for short-term unsecured debt was upgraded to A-2 from A-3. Moody's credit rating and outlook on GFC's long-term unsecured debt remained unchanged at Baa3 and positive, respectively. Moody's short-term unsecured debt rating is P-3. GFC continued to successfully utilize the commercial paper market as a source of liquidity during the second quarter. However, the Moody's short-term unsecured debt rating of P-3 may restrict GFC's future ability to utilize this market. Unconditional purchase obligations at June 30, 2006, consisting primarily of railcar orders and committed aircraft deliveries, were comprised as follows (in millions):

22 NEW ACCOUNTING PRONOUNCEMENTS See Note 3 to the consolidated financial statements for a summary of new accounting pronouncements that may impact GFC's businesses. CRITICAL ACCOUNTING POLICIES There have been no changes to GFC's critical accounting policies during the six month period ending June 30, 2006; refer to GFC's Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005 for a summary of GFC's policies. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Since December 31, 2005, there have been no material changes in GFC's interest rate and foreign currency exposures or types of derivative instruments used to hedge these exposures, and no significant changes in underlying market conditions. For a discussion of the Company's exposure to market risk refer to Part II: Item 7A, Quantitative and Qualitative Disclosure about Market Risk reported in the Company's Annual Report on Form 10-K/A for the year ended December 31, 2005. ITEM 4. CONTROLS AND PROCEDURES The Company's management, with the participation of its Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act")). Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this quarterly report, the Company's disclosure controls and procedures were effective. No change in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) occurred during the quarter ended June 30, 2006 that materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Since December 31, 2005, there have been no material changes or new developments in GFC's legal proceedings. For a discussion of these proceedings, refer to Part I: Item 3, Legal Proceedings reported in the Company's Annual Report on Form 10-K/A for the year ended December 31, 2005. ITEM 1A. RISK FACTORS Since December 31, 2005, there have been no material changes in GFC's Risk Factors. For a discussion of GFC's risk factors refer to Part 1: Item 1A, Risk Factors, reported in the Company's Annual Report on Form 10-K/A for the year ended December 31, 2005. ITEM 6. EXHIBITS Exhibits: Reference is made to the exhibit index which is included herewith and is incorporated by reference hereto. 23 SIGNATURE 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. GATX FINANCIAL CORPORATION (Registrant) /s/ Robert C. Lyons -------------------------- Robert C. Lyons Vice President and Chief Financial Officer (Duly Authorized Officer) Date: August 1, 2006 24 EXHIBIT INDEX

GATX FINANCIAL CORP 10-Q